A Guide to Shares and Shareholders

Introduction

Shares and Shareholders, the foundation of businesses everywhere. Whether you’re a seasoned business pro, or a newbie looking for advice, we’ve broken down some of the key concepts in this guide. From types of shares, through to shareholders agreements and all the exciting tax implications, we’ve given a nice overview to send you on your way. So, without further delay, let’s dive in.

Definition of Shares

Put simply, shares are a way to show part ownership of a business. As described by Investopedia, shares are units of equity ownership in a business. So, if you own shares in a business, you effectively own a slice of the pie. Business owners can decide who gets a slice of that pie, and the reasons why they may issue shares will vary (which we’ll get onto later).

Importance of Shares in Business

Shares are a hugely important element of businesses that help provide financial backing, spread the ownership, and provide a way to incentivise shareholders – creating a shared common goal. Shares go further than just setting out the ownership of a business, they also help influence its culture and growth.

Overview of Shareholders

Shareholders are individuals (or other companies) who own stocks or shares in a company. Owning these gives you a share of the business and also presents you with certain rights. In simple terms, if you buy or are given shares or stocks in a company, you effectively become an owner of it.

Shareholders can come in all shapes and sizes, from individuals who work within the business, to large-scale investors such as mutual funds or pension funds.

Shares can be used to raise funds for both the business itself and for the shareholders. As partial owners of the business, shareholders stand to benefit from the company’s profitability through dividends or capital appreciation. But the benefit of holding shares is not purely financial, shareholders often have voting rights, meaning they influence key decisions, such as new board members, or major business strategies.

As a result, shares can help shareholders play an active role in the direction of the firm, helping motivate and unite team members with a common goal.

Types of Shares

Just like tropical fish, there are lots of different types of shares. Unfortunately, that’s where the similarity ends. Understanding the different types of shares is incredibly important for investors and businesses alike, as each carries its own rights and responsibilities.

Ordinary Shares:

Clues in the name, but these are the most common type of shares issued in the UK by companies. Ordinary shareholders usually have the right to vote at company meetings, letting them participate in important decisions and have a say in how the business operates.

Generally, the more shares an ordinary shareholder has, the more influence they will have on the decision-making process.

In terms of the shares appreciating, ordinary shares operate in a fairly straightforward way. If the company does well and the value of it increases, so too will the price of shares, allowing shareholders to sell their shares for profit.

Ordinary shares are generally easy to transfer, meaning shareholders can buy and sell them on the stock exchange if the business is public or privately if it is not. This level of liquidity can prove to be very attractive for potential investors.

Shareholders may also have pre-emptive rights allowing them the option to purchase either existing shares from other shareholders or additional shares (in proportion to their existing holdings) before the company offers them to the public. So essentially, they get first dibs.

In some cases, ordinary shares may also have convertible features, enabling shareholders to convert their shares into another class of shares with different rights.

The only caveat with ordinary shares is that they’re at the bottom of the list if anything goes south with the business. For example, if the business files for bankruptcy, ordinary shares are last in line for a claim. Keep in mind that this will be once all the business’s debts and liabilities are paid, and other preference shareholders have been paid, too.

Dividends, if declared, are distributed to ordinary shareholders after any obligations to preferred shareholders are met.

What’s a preferred shareholder you ask? Well, lucky for you we’ve described just that below.

Preference Shares:

Preference shares come with preferential rights ranking them ahead of ordinary other classes of shares.

There are no set requirements or rules as regards the preferential right, but it usually relates to the payment of dividends or a priority repayment of capital on a winding up of the company (or both). Unlike ordinary shareholders, preferential shareholders often have a fixed dividend rate worked out as a percentage of the face value of the shares. It provides a level of stability and predictability that can be attractive to shareholders. In the hierarchy of claims on a company’s profits, preference shareholders have first dibs.

However, they often have less voting rights compared to ordinary shareholders which comes as a trade-off with the reliability of its income stream. Ordinary shares are much more likely to fluctuate, preference shares may be shielded from this instability.

It’s worth noting though, that no two cases are the same. Some businesses will set up preference shares and offer different rights than others. It all depends on how the firm decides to divvy it up, which will all be outlined in the articles of association or the shareholders agreement.

Preference Shares with Cumulative Dividends:

In a nutshell, cumulative dividends are a dividend that, if expressed to be payable on set date allow the dividends to accumulate as a debt to the shareholder until paid. So, if for whatever reason the company is unable to pay any dividends one year, these funds will carry over. This accrued amount must also be paid out to cumulative preference shareholders before any dividends are paid to ordinary shareholders. Unless the terms of the reference share provide otherwise, the right to a preferential dividend is deemed to be cumulative, if there is no intention that they are to be it should be expressly specified in the company articles.

Preference shares with cumulative dividends work for investors who are in it for the long haul, who may not be as affected by the company not paying dividends one year for example.

Although they may be great for investors with patience and a long-term approach, they can pose problems for the company. If the business is going through a rough patch, the obligation to pay out accrued dividends can be another financial burden on the company.

Non-Cumulative Preference Shares:

Many businesses will choose to go for non-cumulative preference shares, which have no obligation to pay shareholders any accrued earnings. As stated above the articles should specify this. So, if a company is unable to pay dividends one year, it means the dividends would remain unpaid and wouldn’t be carried forward.

As you can imagine, this offers less certainty than cumulative preference shareholders. With no guarantee on dividend payments, it offers shareholders less reliability but can be beneficial to the firm during tough times.

This flexibility can be attractive to businesses that are aware of the potential burden cumulative preference shares can have during tricky financial spots. For investors, they often appeal to people with a shorter-term view. People who are happy to reap the benefits of a fixed income rate but aren’t as concerned about accruing dividends over the years.

Redeemable Shares:

Redeemable shares have the unique feature that the company can redeem them in the future. They’re often an attractive option for businesses as they offer a level of flexibility that allows them to tweak their equity structure in the future. Redeemable shares must comply with certain provisions of the Companies Act, relating to their terms, conditions and manner of redemption otherwise they will not be redeemable. Redeemable shares might be used as a mechanism for returning surplus capital to shareholders as an alternative to a company share “buyback” which has more onerous requirements under the Companies Act.

How it works is a company has the right, or sometimes obligation, to buy those shares back at a chosen price or a specific situation. What do we mean by specific situation?

Well, it can mean several things. Everything from regulatory changes, shareholder agreement violations or failure to meet performance metrics, all of which can trigger a redemption.

This gives the company flexibility in managing its share capital as it lets it raise capital without permanently increasing its share capital. The option to redeem those shares allows the business to reduce its equity base in the future. It also has the advantage over a share buyback of not having to pay stamp duty on the redemption price of the redeemed shares.

The terms of when these shares can be redeemed are specified at the point of issue, and its vital that any investors study this carefully so they know what they’re signing up for.

Preference Shares with Convertible Rights:

And if you can’t decide between ordinary shares or preference shares, luckily you can have a bit of both. These shares combine elements of both preference and ordinary shares. Shareholders have a fixed dividend rate, but they also have the option to convert their preference shares into ordinary shares after a specified period. The preference shareholder may be able to gain from an increase in the ordinary share price over and above the conversion price set out in the preference share rights, while not being at risk of a drop in the value of the ordinary shares before conversion. They are also usually drafted so that holders are protected from dilution of further rights issues.

Preference shares with convertible rights can be a mixed bag for companies. They’re appealing because they attract a wider range of investors looking for a mix of steady income and the chance for higher returns. This diversifies the sources of company funds and can be helpful for getting capital. However, there’s a downside: the potential for dilution.

If a lot of preference shares get converted into regular shares, it can reduce the ownership of existing shareholders. Companies need to carefully manage this, balancing the fixed dividend payments with the complexities of having different types of shares.

Alphabet Shares:

Alphabet Shares, also known as multiple-class shares, offer the highest level of flexibility compared to other share classes. It allows companies to differentiate between the types of shares offered and the levels of dividends and voting rights associated. Clues in the name, but the different types of shares are represented by letters of the alphabet (e.g. A Shares, B Shares).

So why would business owners choose Alphabet Shares? Well, it lets you tailor each share class to the individual dependent on their level of investment or commitment. They might also use them as part of an employee share scheme to incentivise employees.

Overall, it has the effect of creating a more nuanced relationship between the business and its shareholders. It caters to their needs and supports their specific objectives as an investor, which can be an attractive proposition.

However, the caveat with Alphabet shares is that it introduces a level of complexity to a business’s financial structure. As a result, managing the differing expectations of shareholders can be challenging and needs careful consideration.

Deferred Shares:

Deferred shares grant shareholders rights to receive dividends only after a set period or until certain other conditions are met for example a certain level of profitability is achieved. Essentially, they’re last in line to receive any dividend payments following other share classes. This can pose an issue for investors if the company ever faces financial trouble, but also offers the chance for higher rewards if the business does well.

Deferred Shares often have little to no voting rights which may be off-putting to some investors. As a result, they’re an attractive offer to risk-tolerant investors who are more concerned about capital appreciation than an immediate payout.

So what businesses are suited to deferred shares? Businesses that are restructuring, or have volatile seasonal earnings, or high-growth companies set on re-investing income all may lean towards deferred shares. It allows businesses the flexibility to align their share structure with their financial goals which can be beneficial to some.

How Shares Work

So, that’s all well and good – but how do shares actually work?

For investors, shares offer the chance to make cash in two ways. One is if the value of the company increases, and they choose to sell their shares for profit. The second is through dividends where businesses share their profits to shareholders.  As we’ve covered already, each share class has unique benefits and risks, so its important investors choose the right option.

For businesses, issuing shares is a great way to raise funds. It’s also a fantastic way to reward hard work internally with employee shares. Put simply, when investors buy shares, they contribute to the company’s money pot. Depending on their share class they’re then rewarded with partial ownership of the company, dividends and any potential profits from selling their shares.

So that’s a whistle-stop tour of how shares work, but let’s take a deeper look at the nuts and bolts.

Issuing Shares

1. Initial Public Offerings (IPOs)

When a business decides to go public, it undergo a process called an Initial Public Offering (IPO) where it offer shares to the public for the first time by first listing or admission to trade its securities on a stock market. It’s at this point that people can buy shares and become investors in the company, claiming their own slice of the pie. This also has the effect of raising funds for the business which can be used for all kinds of business activities such as expansions, paying off debts or purchasing equipment. The business will be able to choose where they list their shares and what stock exchanges to use depending on its objectives.

2. Private Placements

Separate to IPOs, placing usually involves offering shares (could be a mixture of existing or new shares) to a select group to allow them to buy shares through private placements. These are often offered to employees, or specific investors. The nature of private placement means that the business can be more selective, and tailor the type of share class on offer to each shareholder and is cheaper than an IPO

Buying and Selling Shares

So, what about the ins and outs of actually buying and selling shares?

1. Stock Exchanges

It might conjure images of people in suits animatedly shouting on the phone, but the stock exchange is more than that. It offers a place for businesses to list shares that can be bought and sold by investors. It’s essentially the modern-day marketplace for shares on a mass scale.  Different stock exchanges exist for different countries and regions, and different businesses will choose which best suits their needs. Which exchange a business chooses will be dependent on their target market and where they operate. For example, businesses operating largely in the UK and Europe, will lean towards the London Stock Exchange (LSE).

2. Online Trading Platforms

If you’re reading this article it’s likely you’ve already been targeted by an advert from an online trading platform.

Well, they’re now more popular than ever, allowing investors to invest their funds online into businesses they believe will succeed. With the popularity of trading websites and apps increasing, investors need to be vigilant of scams. In the UK, check the platform is approved by the Financial Conduct Authority before you decide to invest as an extra layer of safety.

When an individual buys shares, a Share Purchase Agreement is drawn up as a way of outlining the roles and responsibilities of both parties so everyone knows what to expect.

What are the rights of shareholders?

“With great power comes great responsibility”.  As much as you may want to sit back and wait for the cash to roll in, being a shareholder does bring some responsibilities.

Let’s get into it:

Voting Rights

As discussed earlier in the article, a different class of shares might bring its own unique voting rights or no voting rights at all. Each class will have a varying level of influence on major business decisions such as what directors are appointed or what direction the business will take. For example, ordinary shares will have voting rights where investors can have a say, whereas deferred shares often have little to no voting rights. It all comes down to what the business wants and what the investor wants. Businesses that’d like to benefit from the capital injection that shares offer but still want autonomy over decision-making may only offer a class such as deferred shares to investors.

Whereas a business that takes more pride in being a company with a communal vision will give its shareholders more control through voting rights. Neither approach is right or wrong, it purely depends on the situation. The same goes for the investors. Some investors will quite happily sit on shares hoping for an appreciation in value, with no real wish to have any say. Whereas others will want to have more control over what goes on with their investments.

Some mechanisms allow investors to let other trusted people vote on their behalf. This is known as proxy voting. It’s often suited to investors who are either unable to, or would rather not, attend shareholders’ meetings. The reasons behind this can vary. They may be large institutional investors with hundreds of businesses in their portfolio, or they could be restricted physically from health issues. Proxies are also used to represent minority shareholders en masse, as individually they may not have enough influence to get a ‘seat at the table’.

Dividend Entitlements

In a nutshell, dividends are payments or distributions made to shareholders when a business makes a post-tax profit.

As a shareholder, you may be entitled to a portion of the business’s profits through dividends, particularly if you have ordinary shares.

When, and how much they are paid will differ depending on the type of shares the investor holds and how many shares they own.

The dividend policies will be determined by the board of directors and will be outlined in the company’s shareholders agreement or its articles of association. The policies are drafted in alignment with the business’s wider financial and strategic goals and vary from business to business.

The types of dividends include everything from straightforward cash payouts, stock dividends where shareholders are rewarded with more shares, or even property dividends where shareholders are given a share of a physical asset, bond or other securities (dividends in specie), though these are quite rare.

Pre-emptive Rights

So, if business was to continually give away more shares, would that not lessen the value of the shares held by previous investors? To stop this happening, pre-emptive rights can be incorporated into a share class or a shareholder’s agreement to give existing shareholders first dibs of any additional shares before they’re offered externally. This lets them maintain their ownership percentage and protects their interests from dilution. This is particularly key for maintaining influence in the business and retaining voting power when new shares are issued.

Right to Inspect Corporate Records

As a shareholder, although they might have voting rights and dividend entitlements they are not automatically entitled to inspect all the records of the company under the model articles of association unless provide by law, a director or an ordinary resolution. The company’s business records can include everything from financial statements, company accounts, meeting minutes and any other core corporate documents.  To ensure that they get full transparency in the business it is a good idea to have all the shareholders enter into a shareholders agreement, which specify to right to inspect. They could also amend the articles of association to document this.

This is also a legal compliance issue, where shareholders can ensure the business is operating in accordance with legal and regulatory requirements, they can be sure no funny business is going on and that their investment is in safe hands.

If they do suspect something untoward, the right to inspect corporate records provides the framework for escalating matters. If they believe the business isn’t operating in their best interest, or acting suspiciously, then inspecting records can be the first step before any potential legal action.

Responsibilities of Shareholders

It’s not all take, take, take in life, shareholders do have responsibilities as well you know…

Shareholders play an incredibly important role in the success of businesses, and their responsibilities can vary, based on factors such as the types of shares and how many shares they hold and the company’s structure.

Other responsibilities that  shareholders can take on include:

• Exercising Voting Rights – Dependent on the share class, shareholders have the responsibility of taking part in shareholders meetings, either in person or through a proxy.
• Monitoring Company Performance – it’s very much in the interest of the shareholder to keep on top of the financial performance of the business.
• Advocating for best practice – shareholders should be advocates for transparency, ethical conduct, accountability and fair treatment across all of their businesses.
• Dividend Decisions – if the shareholder has voting rights, they should be comfortable contributing to discussions around how dividends will be distributed to other shareholders.
• Promoting Sustainability – Shareholders should consider the long-term sustainability of the company. This involves evaluating the environmental, social, and governance (ESG) practices to ensure responsible and sustainable business operations.
• Understanding Legal Obligations: Shareholders should be aware of their legal obligations, including compliance with securities laws, disclosure requirements, and any contractual agreements with the company.
• Staying Informed: Shareholders should stay informed about market trends, economic conditions, and developments in the industries in which their invested companies operate.

The Benefits of Owning Shares

Potential for Capital Appreciation

One of the first benefits that might spring to mind for shareholders is the chance of capital appreciation. If the value of the business increases over time, so to do the value of the shares, meaning they can sell them for a profit.

Dividend Income

A lot of companies will distribute a portion of their post-tax profits to shareholders in the form of dividends. This can provide a tidy passive income for shareholders who profit from the success of the businesses they partially own.

Having a Say

Shareholders with voting rights can play an active role in the decision-making process of a business, meaning they can really feel involved in the direction of the firm. Shareholder’s quite literally own a share of the business, and that sense of ownership can be a powerful motivating factor. If the firm does well, often so too do the shareholders.

Easy to Transfer

Unlike an asset such as property, shares might be more easily transferred, particularly if held in a listed company, meaning they offer a level of liquidity, that can be attractive to shareholders. This level of liquidity makes shares an attractive option for investors.

The Risks of Owning Shares

Risks of Market Volatility

The old adage of ‘only invest what you’re prepared to lose’ might seem extreme, but it applies here. Share value, for both privately and publicly held shares can fluctuate, and they’re also affected by lots of external factors such as the economic climate, market conditions and whatever is happening in the business at that time. This all makes for a level of unpredictability that should be kept in mind by investors. Nothing is ever certaint, and if something sounds too good to be true – it usually is.

Poor Business Performance

If the business you own shares in unexpectedly has a bad few years, it may lead to a decline in the value of the shares. Or if the business operates in a particularly volatile market that is prone to ups and downs, share values will also be impacted by this uncertainty.

Lack of Control

Depending on the type of share class an investor has, they may have little control over the business. This is particularly true for minority shareholders as major decisions are often made by the board of directors and majority shareholders.

No Guarantee on Dividends

Again, depending on the type of share class held, there is no guarantee for dividend payments for some shareholders. While some shares may not pay regular dividends, they may offer other benefits such as voting rights or capital appreciation.

Shareholders Agreements

Tying everything we’ve discussed together is the humble Shareholders Agreement. So what is a shareholder’s agreement I hear you ask?

Shareholders agreements govern the relationships, rights and obligations of shareholders and act as the glue that holds everything together. They aim to provide clarity on how the business operates, along with providing protection if there’s a breach of a shareholder’s agreement.

Shareholder’s agreements are entered into voluntarily by shareholders.

They cover all the key aspects of how the individual business will operate, including: any transfer restrictions that control share transfers, buy-sell agreements that dictate mechanisms for share sales, and provisions for drag-along and tag-along rights.

Other aspects that it covers include dispute resolution measures, board composition, confidentiality, non-compete clauses, deadlock resolution, dividend policies, exit strategies, and shareholder rights and obligations.

In a nutshell, shareholder agreements ensure businesses are run fairly, that there’s protection should things go wrong, and that shareholders have their rights and responsibilities outlined. Also known as Deed of Partnerships, the document’s flexibility and adaptability make it a crucial tool for shareholders in customising their arrangements to suit the specific needs of their company.

Tax Implications for Shareholders

Of course, as with anything, there will always be tax repercussions, making it incredibly important to factor in the tax implications of owning shares. So, on that note, we’re going to dive into the world of shareholder taxation, strap in.

Capital Gains Tax

Capital Gains Tax (CGT) is a tax put on the profit gained from the sale or disposal of any asset, shares included. It’s calculated by determining the difference between the selling price and the original purchase price.

So, when it comes to shareholders, they could face Capital Gains Tax when selling shares.

The next question from business owners will be how much tax will they have to pay?

The tax rate depends on how long the shares have been held, the income level and what jurisdiction they’re held in.

Generally, shorter-term holdings may incur higher CGT rates compared to long-term holdings, which may benefit from lower rates or exemptions.  This makes it incredibly important to time the sale to optimise annual allowances, whilst using tax-efficient investment structures to mitigate any potential CGT.

Sounds complex, doesn’t it? Well, it’s always worth speaking to both a solicitor and a tax expert to ensure you’re doing things efficiently.

To see a breakdown of CGT tax, check out the latest government guidance.

Dividend Tax

So as a recap, dividends are payments made to shareholders as a way to distribute profits and are generally paid as cash.. (It’s important to remember that you only get paid dividends if the company is making profit.)

So, when a shareholder receives dividends, they may be taxed, depending on their total income. Fortunately, everyone receives a Personal Allowance in the UK, meaning if the dividends fall within this, you won’t be taxed.

On top of this, you also get a dividend allowance each year, and then you only pay tax on any income above and beyond this.

For the tax year 2023-2024, the dividend allowance is £1000. Any income above this is taxed based on your income band, which ranges from between 8.75% and 39.35%.

If your dividends exceed £10,000, then you’ll need to fill out a Self-Assessment Tax Return. However, if your income is lower than the threshold then you may not need to inform HMRC.

It’s also worth noting that any dividends from shares held in an ISA are not taxed at all.

(An ISA is an Individual Savings Account that acts as a tax-efficient savings and investment account. There are all different types of ISA, check out the full breakdown in this article from the UK government.)

Conclusion

In this comprehensive guide to shares and shareholders, we’ve set out the framework for how many businesses operate. From understanding the basics of share ownership, to the intricacies of what different shares offer. Hopefully, we’ve provided enough information to send you on your way.

As always, it’s important to seek proper financial or legal advice when undertaking any major business decisions, and this article was designed just to scratch the surface of a complicated topic.

With any major business decision, it’s important to prioritise well-informed decision-making before making any commitment.

If you’d like to speak to our team about any of the areas covered in this article, get in touch today.

Find out more about how we could help your business with shareholder’s agreements.