When starting out as an entrepreneur, you may be choosing between a sole trader business structure or a limited company (also known as incorporated). The latter option will require you to answer the question ‘What is share capital?’ along with gaining an understanding of the workings of share capital, the rights, the legislation and the most advantageous way to manage it. Learn it all here.
First things first – what is share capital?
This term refers to the money invested by the founders and owners of a company that has a limited business structure. In the case of more than one owner, the amount of money that each owner invested as a percentage of the total money invested is called their share capital, and they are called shareholders or company members.
Each company is required to have a minimum of one share. The shares are called ordinary shares and each one has a ‘nominal value’ initially of £1. Ergo, for each pound an owner invests in the company, one share is issued to them. The nominal value and market value are different in that the latter can be of much greater value. The difference between the two share values is called the premium. If you are paid out at the higher value, then you are paid out at ‘premium’.
You might want to issue some shares at the premium value. If you do, the company is obliged to deposit the premium amount into a dedicated bank account. This is called the ‘premium account’ and these are untouchable reserves. There are very few occasions when you may access these funds. Always check with your accountant before taking any action with these funds.
When there are multiple shareholders, the shareholder(s) with the most shares has the most control over the business. All shareholders’ financial rights over the company are:
Their shares of the company’s net profits will be split according to the share percentages when paid out.
The final payouts, on liquidation, will be split according to share percentages.
The liabilities on liquidation are also split according to share percentages.
The legislation does not limit how many shares can be issued. You, and your partner if there is one, will decide on the share ceiling at the time of company set up. This ceiling is called the authorised share capital and it is recorded in the company’s Articles of Association.
What are the different types of shares?
When allocating shares to shareholders, decide what type of shares are allocated. The different classes of shares are:
Preference shares – Dividends and liquidation payouts are paid to the holders of these shares before any other shareholder. Cumulative preference shares transfer the ‘first in the queue’ rights to the following year if there wasn’t enough profit to pay out in the current year. Venture capital companies usually require preferential shares.
Redeemable shares – The company retains the right to buy these back in future years.
What is the advantage of a share structure in a limited company?
There are many advantages to using a share structure and a limited company:
Your personal liability is ‘limited’ unless:
You signed personal guarantees; or
You contravened business management legislation.
Company tax and your personal tax are treated separately.
You can raise capital by giving shares to investors instead of bank loans.
A limited company is more attractive to buyers.
Investment schemes, vehicles for boosting the growth of businesses, prefer limited companies.
Employee incentive schemes can include share issuance at certain milestones.
How many shares should you issue?
There is no magic formula except ‘keep it simple’. You can have one share, but usually one hundred are issued.
What are the pros and cons of share capital?
Having a limited company with shares is perceived as a more professional setup than a sole trader setup, but there are complex reasons as well. Here are some advantages:
Using share issuance to gain investment is a lower risk because a company is not obliged to reimburse share capital to the shareholders.
Dividends are not obligatory, i.e. a company does not have to issue dividends.
A limited company with shares cannot be forced into insolvency by the shareholders.
Venture capital investors usually come with knowledge and skills advantages as well as a valuable network.