Last updated on September 18th, 2020 at 09:20 am
Guidance notes to new articles of association (alphabet shares)
This guide aims to explain what alphabet shares are and sets out how to correctly amend the template articles so as to properly implement an alphabet share scheme.
What are alphabet shares?
Alphabet shares provide businesses with an alternative way of raising equity finance as their company begins to expand and more shareholders join the company. A company that is limited by shares will have been set up with a nominal number of ordinary shares in issue.
Alphabet shares allow the business to effectively assign their shareholders with shares in different classes, and these separate share classes are identifiable by a specific letter (hence the term ‘Alphabet Shares’). For example, this could mean that the company has categories of shares such as “A” Ordinary shares, “B” Ordinary shares and so on.
The use of alphabet shares could help a business to pay shareholders different amounts of dividends depending on what class of share they own. Alternatively, alphabet shares are used in companies owned by families or in joint ventures so as to give certain shareholders power to make important decisions (for example to appoint a director).
Something important to note here is that if your company’s articles of association do not identify what rights are attached to each different class of share then they will rank pari passu with one another – meaning they all rank equally. This could lead to shareholders becoming unhappy as a situation could materialise where one shareholder who owns a class of shares that represent a minimal amount of money could be entitled to the same dividend rights as another shareholder who owns a class of shares that represent a significant amount of money.
To avoid this, ensure that your company’s articles of association are amended via a special resolution of the shareholders so that the rights attaching to each different class of share is added. Once this has been done, one rate of dividend can be paid to the shareholder(s) owning, for example, “A” Ordinary Shares and a different rate can be paid to the shareholder(s) owning “B” Ordinary Shares.
Such an amendment to your company’s articles is essential in order to circumvent the ‘model article’ and ‘Table A’ provisions that demand dividends be paid in proportion to the number of shares held. As mentioned above, unless otherwise stated in the articles of association, in relation to all other rights such as voting and rights to capital on a winding up, the different classes of shares will usually rank equally.
Typically, the process of implementing an alphabet share scheme involves the following:
- The company creating a new class of shares (or classes of shares);
- Detailing the rights attaching to the new share classes in a set of new articles of association;
- Ensuring that these new articles detailing new share class rights are adopted by special resolution (this can be a written resolution);
- The company deciding (once the new share classes have been created) to either allot new shares of the classes concerned or have existing shares converted to the new classes (which route is decided upon will impact what statement of capital forms need to be completed and filed at Companies House);
- Both directors and shareholders considering and approving the changes to the company’s existing articles; and
- Sending notices of the relevant statutory forms and shareholder resolutions (along with a dated copy of the new articles) to Companies House within the prescribed time limits.
Your input is required at the parts of the template highlighted in yellow and the wording inside the square brackets which we have included explains clearly the information that should be inserted. You are advised to fill in the wording in square brackets in lower case unless directed otherwise. Any figures should be entered in numerical form. The brackets should be removed after the amendments are made (so as to produce a ‘final form’ set of new articles).
These articles are intended as a template only and must be adapted to the particular circumstances of your case.
Article 1 (Introduction)
Article 1.1 confirms that the company’s existing articles of association that it was incorporated with shall continue to apply to the company, save insofar as they are varied or excluded by, or are inconsistent with, the new articles. If the company has amended its articles of association since incorporation, amend this article accordingly and insert the date that the company’s most recent/up-to-date articles of association were filed at Companies House.
Article 2 (Defined terms)
We have drafted the template articles on the basis that the company will be creating three new share classes (being A Ordinary, B Ordinary and C Ordinary classes). You can amend this depending on your purposes and can have more or less share classes as you desire.
For each new share class, you should insert the nominal value in the square brackets provided.
Article 2 sets out the definitions that will apply throughout the new articles – the main purpose behind this is to reduce repetition within the body of the articles, making them shorter and easier to read. In addition, as it gives specific meanings to particular terms used in the articles, it also avoids ambiguity and makes it clear that those terms are intended to include matters which they might otherwise be found not to cover (or vice versa). Unless expressly defined, the courts will interpret non-technical terms in accordance with their ordinary and natural meaning, or the meaning which can be inferred by the words that the parties chose to use in the articles. Extrinsic expert evidence may be necessary to interpret technical terms not defined in the articles themselves.
Article 3 (Rights attaching to shares)
Our template articles have been drafted on the basis that the main intention behind the implementation of the alphabet share scheme is so that the company (via its directors) can pay the holders of the different classes of shares different rates of dividends above their pro rata entitlements. The reasoning for this is because this is the most common motive our clients have behind wanting to implement such schemes.
As regarding voting
With regards to voting, if you choose the first optional provision, this will mean that the different share classes rank equally as regards to voting. The articles of a private company limited by shares will usually provide that each resolution put to the vote at a general meeting will be decided by a show of hands unless a poll vote is duly demanded. The articles will (again, usually) who is entitled to call a poll. On a show of hands, the default position under the Companies Act 2006 is that every shareholder present in person has one vote, regardless of the number of ordinary shares held. On a poll, each shareholder has one vote for each share held. This default position can be varied by a company’s articles and so the specifics of the company’s articles will need to be considered.
The second optional provision contains an example of an alternative way the articles could be drafted as regards to voting. It provides that the A Ordinary and B Ordinary shares carry different number of votes per share, and that the C Ordinary shares do not carry any voting rights. You can tweak this optional provision to fit your circumstances if you do not wish for the different classes of shares to rank equally as regards to voting.
As regarding dividends
If you wish for the shareholders of the new share classes to receive equal dividends when the company’s directors determine that there are sufficient distributable profits available so as to justify declaring a dividend, you should use the wording contained within the first optional provision under this section. This will result in the new share classes being treated as if they were the same class of share and have equal rights as regarding dividends.
If you wish for the company’s board to be able to declare different (i.e. unequal) amounts of dividends in respect of each share class, then you should choose the second optional provision. This will result in the new share classes being treated as different classes of shares for the purpose of distribution of company profits by way of dividend.
The second optional provision gives the directors of the company the power to determine the amount of dividend that each share class should receive. This power means that the directors can designate dividends to the different share classes either above or below the relevant shareholders’ pro rata entitlements. This power is limited in that when making such a decision in terms of apportionment of dividends between the separate share classes, at majority decision of at least 75% of the directors must be passed in order to approve such an apportionment. If there are two company directors, then in order to meet this requirement under those circumstances there would need to be unanimous agreement between the two of them.
In order for a company to be able to lawfully pay a dividend, it must have sufficient distributable profits that are justified by reference to relevant accounts. This detail is set out in the second optional provision and confirms that the company’s accountants for the time being must first certify whether such distributable profits are available or not (and the amount of such profits) before a dividend is declared.
Note that the Companies Act 2006 does not specify who shall declare dividends and, in particular, there is no requirement for any dividends (whether final or interim) to be declared by shareholders (in the case of private companies, by written resolution). Therefore, if a company’s articles are silent on the point (and the model articles for private companies limited by shares have not been adopted), directors would be entitled to declare all dividends (final and interim) without the need for such declaration to be sanctioned by the company’s shareholders.
Under the model articles for private companies limited by shares, model article 30(1) provides that “The company may by ordinary resolution declare dividends, and the directors may decide to pay interim dividends”. Standard practice in these circumstances mean that, whereas directors can resolve to pay interim dividends, final dividends should be recommended by directors but declared by shareholders by ordinary resolution.
As regarding capital on winding up
The first optional provision under this section of the articles confirms that the A Ordinary, B Ordinary and C Ordinary shares shall be treated the same for the purpose of distribution of capital on winding up, with distributions under such circumstances being made on a pro rata basis. You should opt for this provision if you would like the different share classes to rank equally as regards to distributions of capital on a winding up of the company (and for the shareholders of the different classes of shares to each receive their pro rata entitlement).
Alternatively, you could choose the second optional provision which provides that the A Ordinary Shares have a preferential right to capital on a winding up of the company, with the B Ordinary Shares ranking second (above the C Ordinary Shares) and the C Ordinary Shares ranking last as regards capital distributions. This provision can be easily tweaked to fit the particular scenario depending on what level of priority you wish to give to the different share classes.
You may also consider adding the following or other types of rights:
- Restricting the transfer of other classes of shares or further shares in a particular class being allotted by the company (so as to protect the shareholders in each class from dilution);
- Specifying that holders of certain classes of shares do not have the ability to appoint/remove directors.
Note that under the model articles of association for private companies limited by shares, model article 17(1) provides that a director can be appointed by way of ordinary resolution (i.e. a resolution passed by a simple majority of the shareholders of a company – meaning more than 50% of votes cast are in favour of it) or by a decision of the directors. A company may wish to control which shareholders can appoint and remove directors and so could insert provisions into the new articles to make this clear. Note further that directors of a private limited company can also be removed as a director by an ordinary resolution in accordance with section 168 of the Companies Act 2006.