If you’re thinking of setting up your own limited company, one concept you’ll need to get to grips with is the whole area of shares.

Emily Coltman FCA, chief accountant to award-winning online accounting software provider FreeAgent, gives an overview of the rules around shares in a private limited company.

What is a share?

A share is a means of owning part of a limited company, because a limited company is a separate legal entity in its own right. Someone who owns one or more shares in a limited company is called a shareholder. A limited company will always have at least one shareholder.

A share entitles the shareholder to part ownership of the whole company – a shareholder would not own specific assets of the company, such as a computer or furniture, since these belong to the company. Think of it like a syndicate who owns a racehorse – each member of the syndicate will own part of the horse, but no one member would own, for example, the horse’s forelegs, or its head. Those belong to the horse.

Shares in your new company

When you set up a company, you need to decide how many people will own shares in that company, and how much each share will be worth (this is called the share’s nominal value, or par value). As part of the process for setting up the company, you will tick boxes to have the company issue one or more shares to its shareholder(s).

If you’re the only individual who’s going to run and own the company, the simplest solution is to have the company issue you with one share worth £1.

If you want the company to have more shareholders, such as family members, or investors, then you need to plan who would receive what by way of dividends, and also who might be entitled to vote at company meetings. It’s worth pointing out that a company is not legally allowed to pay dividends unless it has enough profit (not cash) left over after allowing for corporation tax.

Ordinary vs preference shares

You might have heard these terms and wonder how they might apply to your company.

1 – Preference shares

Preference shares have a fixed rate of dividend (so you would have, for example, 7% preference shares, which entitle the shareholder to a 7% dividend), and also preference shareholders come higher up the pecking order for claim to an insolvent company’s assets than ordinary shareholders. Often, though, preference shareholders don’t have voting rights at company meetings.

2 – Ordinary shares

Ordinary shares are shares that are not preference shares. They don’t attract a fixed rate of dividend, and if the company is later wound up and all its creditors paid off, the ordinary shareholders are the last on the list for repayment of what they’ve invested. Ordinary shareholders can vote at company meetings.

A very small company with only one shareholder will typically only issue one ordinary share and no preference shares.

3 – Multiple shareholders

If you want your company to have more shareholders, you may decide to issue different classes of ordinary shares (for example, ordinary A shares, and ordinary B shares), so that you can have the company pay dividends at a different rate to various shareholders – this is because dividends are always paid at a rate per share, so shares in the same class will be entitled to a particular rate of dividend.

Let’s see how this might work.

Mrs A and Mrs B set up company AB Ltd. Mrs B has a full-time job and so only wants to have AB Ltd pay her dividends up to her dividend allowance. Mrs A, on the other hand, works only for AB Ltd and wants to have more dividends. Their accountant advises that Mrs A be issued with one ordinary A share and Mrs B with one ordinary B share, so that the company can pay a higher rate of dividend to Mrs A than to Mrs B.

Shareholders can waive their rights to receive dividends, but this is problematic as HMRC may challenge it, and the papers must be drawn up carefully. You can find more information about this here http://www.itcontracting.com/what-is-a-dividend-waiver/

Paid or unpaid shares

When your new company issues you with a share that’s worth £1, you may decide to put £1 into the company’s bank account to pay for that share straight away. Or, if the company already owes you some money (perhaps because you’ve personally paid for some of its early costs, such as getting business cards printed), then you might opt to take the £1 off the amount the company owes you – in other words, reduce your director’s loan account balance by £1.

If you don’t put the money into the company bank account, and the company doesn’t already owe you any money, then the £1 will sit on the company’s balance sheet as “called up share capital not paid”, along with other money owed to the company by people such as customers with unpaid invoices.

Shares not yet paid for still entitle their holders to receive dividends and to vote at meetings, but if the company is wound up, the shareholder will then have to pay the value of any unpaid shares back to the company.

When shares change hands

If you want to transfer existing shares from one person to another, there’s a specific process you need to follow in order to do that – briefly, you need to tell Companies House that the shares have changed hands. Here’s more information about that. 

If you want to issue more new shares in your company, perhaps for a new business angel, then you will need to call an official meeting of the shareholders (even if that means you, as only current shareholder, having a meeting with yourself!) and resolve to issue these shares. You will also need to tell Companies House that you’ve issued more shares in the company. 

Emily Coltman FCA is chief accountant at FreeAgent, who make award-winning cloud accounting software for freelancers, micro-businesses and their accountants. Try it for free at www.freeagent.com