Last updated on July 21st, 2020 at 04:22 pm
A common mistake I often come across is when founders want to offer shares to new shareholders, such as incoming investors or directors, they often think to transfer existing shares. Instead they should in most cases issue a relevant number of new shares to dilute the existing shareholder(s) accordingly and thus avoid capital gains tax on the otherwise increased value of existing shares that would be transferred.
However, issuing shares is a more complex procedure than the majority of people expect. The following is a general, although non-exhaustive, guide to the main rules and procedural steps that apply to the allotment and issue of shares in a private limited company in England and Wales, Scotland and Northern Ireland.
Unless you are absolutely certain that you know what you are doing, it is a good idea to get an experienced professional to assist you with any new issue of shares as any mistake made is likely to cost you time and/or money to rectify.
The documentation noted below will also often be accompanied by an investment agreement which will contain a number of protective provisions for the new shareholder(s) investing, while also acting as a shareholders agreement to govern the relationship of all parties on an ongoing basis.
As a general note, you will always need to first check your company’s constitutional documents (the articles of association, together with a shareholders agreement if this also exists) to see if there are any restrictions or procedural points that will apply to the share issue which will vary the law as otherwise set out in the Companies Act.
Also, before issuing new shares it will often be necessary to first subdivide a company’s existing share capital.
A company, particularly one with earlier investors as shareholders, may want or need to carry out a pre-emptive open offer of new shares to its existing shareholder base before then issuing the balance of any shares remaining after such offer to the existing shareholders on the same terms.
When issuing new shares it is always recommended to have a good contract in place, commonly referred to as a ‘subscription agreement’, that clearly sets out the terms (including how exchange and completion work) and helps facilitate the deal smoothly. Companies may also want to update their constitution (adopt new articles of association and/or a shareholders agreement) to govern the ongoing relationship between the shareholders and the company.
At our shop we have template versions (along with detailed guidance notes) of both a subscription agreement and a shareholders agreement, as well as template shareholder resolutions and board minutes covering the issue of new shares.
1. Authorised Share Capital
Since the Companies Act 2006 came into force there is no longer the concept of authorised share capital. If you are dealing with a company formed since then you can issue new shares without being concerned about there being any authorised share capital.
However, if the company was incorporated under the Companies Act 1985 and the authorised share capital appears in a company’s memorandum registered prior to the 1st October 2009, without having been subsequently removed, then the notion of authorised share capital will still be applicable and will continue to act as a limit on the number of shares that can be issued.
In this case, if there is not sufficient authorised capital available, it will be necessary for the company to either:
a) pass a special resolution (75% of shareholders) and amend the articles to remove the restriction; or
b) pass an ordinary shareholders resolution (a majority of shareholders) and increase the authorised share capital so there is enough to allot the required number of new shares.
2. Authority of Directors to Allot Shares
In many cases the directors must be given authority by the shareholders to allot new shares, even where the directors and the shareholders are the same people.
‘Allotment’ is the process by which a person acquires an unconditional right to be issued with shares. Directors allot shares on the company’s behalf, but either the company’s articles or an ordinary resolution of the company needs to first authorise them to do so.
However, an exception to this is that a private company incorporated under the 2006 Companies Act without any relevant restriction in its articles, that will only have one class of shares following the allotment, does not need any prior authorisation from the company’s shareholders in order for the directors to allot new shares.
The wording in the resolution granting authority to allot must state the maximum number of shares that can be allotted and must also give the date on which the authority will expire. This must not be more than five years from either the date of the authorising resolution or, if the authority is included in the articles, incorporation.
A resolution can either be passed by the shareholders in a general meeting or by circulating it in written form and receiving back from the shareholders the requisite number of signed copies. The authority to allot resolution will often be combined in the same document as the other resolutions that are necessary, such as to disapply pre-emption rights, which when executed is filed at Companies House within 15 days after the resolutions have been passed.
3. Existing Shareholders and Pre-emptive Rights to New Shares
The next step is to check that the issue of the shares complies with any applicable pre-emption rights. These require new shares to be offered to existing shareholders first, in proportion to the number of shares they already hold.
These rights of first refusal over issues of new shares are designed to protect shareholders by allowing them to have the chance of preventing the dilution of their shareholding so long as they have sufficient funds available to subscribe for the new shares.
Pre-emption rights are statutory and contained in the Companies Act, although may have been varied by the company’s articles of association or any shareholders’ agreement. A private company’s articles of association may even exclude pre-emption rights altogether.
If there are any pre-emption rights, you will likely want to alter, vary, disapply or waive the existing provisions in respect of the new issue of shares. This will require a special resolution which, again, you can either have passed by the shareholders in a properly called general meeting or instead by the circulation and return of an executed written resolution. Alternatively, the existing shareholders could waive their rights to the new shares by means of a simple waiver letter.
4. Shares are Allotted by the Directors
Once the requisite shareholder resolutions have been passed, whether in a general meeting or by written resolution, the board should resolve to allot the shares, stating the number and class of shares, the allottees, the price paid, when and whether for cash or other assets. As with all other decisions of the directors, a set of board minutes must be taken recording the decision and kept for ten years. Upon receipt of acceptances and any payments due, the board will issue the shares.
5. Registration and Filing
The registration requirements (traditionally attended to by an appointed company secretary, but private companies are no longer required to have such an officer) are as follows:
a) Issue share certificates to the new shareholders (a sealed or duly executed share certificate is prima facie evidence of title to the shares to which it relates);
b) Complete the Companies House SH01 form (statement of capital). The form must be sent to and filed at Companies House within one month of the allotment of shares;
c) Also file at Companies House any ordinary resolution passed in respect of the directors’ authority to allot shares, as well as any special resolution passed to alter, vary, disapply or waive any pre-emption rights (shareholder resolutions are required to be filed at Companies House within 15 days of the date they were passed); and
d) Amend the company’s statutory register of members which the company maintains itself with its own records (the register of members is the primary evidence of who owns the shares).
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