Traditionally, when a limited company is incorporated, it is set up with a single share class, meaning that all shares issued carry the same rights and entitlements.
A share generally carries three types of rights: they might be able to vote on shareholder decisions, receive dividend returns and receive capital in the event of winding up or third party sale. In a single share class company, the shares issued will have all three of these rights and are usually described as ‘Ordinary’ shares.
The difficulty with Ordinary shares and a single share class structure is that they are generally quite inflexible. If you have two shareholders who own 50% of the business each, for example, then they must vote on decisions in those proportions, receive dividend returns in those proportions and would equally receive capital on winding up or sale. This may suit some who want all things equal but makes things complicated should the business want to differentiate between shareholders, for example, those who are seeking investment or want to incentivise employees.
Unlike Ordinary shares, Alphabet, or A & B shares, allow you to assign different rights and entitlements to each category of shareholder, for example, shares issued to employees may only have a right to capital in excess of what the business was worth at the date of the issue. The reason behind this is to ensure the Founding shareholders aren’t giving away any of the value they alone have generated.
A further example is where a company decides that dividend returns should be distributed in proportions not equal to the number of shares held by each shareholder. Historically, companies would use dividend waivers to achieve this, however, they come with their own complications and can often be seen as provocative by HMRC. Implementing Alphabet shares and having share classes with different rights allows a company to vote varying levels of dividends to each share class. This is sometimes particularly useful, especially between spouses, where income can be charged at lower rates of tax.
We have seen a growing trend in companies reclassifying their share capital to bring in additional shareholders. Restructuring your shares in this way can be effective in a wide range of scenarios, not limited to the two examples described above.
Whilst we support the use of multiple share classes and the flexibility they provide, restructuring your business should be approached with caution. Tax planning legislation can be complex, particularly in this area, and any transactions undertaken should only be done so after taking professional advice.