Calculator © - Free Online Calculators

Online Calculators since 2009

## Contractor Section:

Home 2020 Tax Calculators Contractor Calculators Contracting Guides

# Understanding How Limited Company Shares Work

When you set up a Limited Company, you will raise share capital and issue shares to shareholders. Before forming a Limited Company, you will have to decide on the share capital and how many shares you want to issue. Shares and its related aspects can be quite confusing for new contractors. To help new contractors in improving the understanding of shares, this article of 'Path of Education for New Contractors', answers the following questions.

• What is a share in a Limited Company?
• What are the different classes of shares?
• Why do companies issue shares?
• How many shares should a company issue?
• What is the nominal value of shares?

## What is a share in a Limited Company?

To define it simply, a share in a Limited Company is like a share in any other physical asset, say a property. If a property is divided into three parts among three inheritors, each inheritor is said to have a share in the property.

Similarly, in a Limited Company, a share refers to a unit of ownership in the company. Before starting a business, the founders of the business invest capital in the company. In return for their investment, investors get a share or stake in the company.

Example 1: You start a company with an investment or capital of £6,000. In return for the cash, you will issue shares worth £6,000 to the investors. If there are three investors investing £2,000 each, you will issue shares worth £2,000 to each investor. If you are starting a one-man company, you will issue all shares to yourself.

## What are the different classes of shares?

While every shareholder owns a part in the company, not all of them have equal rights when it comes to running the company. Shares are of different classes, with each class having different rights for voting on the companys critical decisions and different rights on a share of profit (dividend). Some classes of shares are ordinary shares, preference shares, non-voting shares, A shares, B shares and so on.

Typically, most small and medium-sized companies issue only ordinary shares. Shareholders of ordinary shares have complete rights on dividends, full voting rights at meetings, and if the company is shut down they have complete right on capital (after paying debts). Within ordinary shares, there can be different classes like Ordinary A with one voting right per share and equal right over dividends, or Ordinary C with no voting rights but equal rights over dividends.

## Why do companies issue shares?

When a company issues shares, it essentially creates new shares to pass on to shareholders. While, the primary reason for issuing shares is to raise money, companies issue shares for different reasons. Let's look at some of the reasons of why companies have to issue shares.

To commence trading: When a Limited Company begins operations, it needs to issue shares to raise money and start operations. The early shareholders are also called as 'subscribers.'

Business growth: Once a business has survived the initial stage and has achieved consistent revenues and profitability, it will require additional money for growth. Issuing new shares can help the company in raising additional capital. Same could be true if a company needs capital for funding an upcoming, high potential project.

Improving balance sheet: Sometimes a company issues shares to improve its balance sheet, let's say, by repaying existing loans or by increasing available cash.

Issuing shares for buying another company: You may issue shares to raise cash for buying a new company. Alternatively, you can also issue shares to the shareholders of the company you plan on buying. The shareholders of the target company will exchange their shares in the old company with shares of your company.

Issue bonus shares: Companies may issue bonus shares from their existing profits to current shareholders. In other words, the companies may choose to reward the shareholders with additional shares instead of dividends. One of the advantages of bonus shares is they increase the share capital and make the company more attractive to prospective investors.

Growth for employees: New shares are issued if a new Director joins the company or if an existing employee is made a Director. New shares can also be issued to new or existing senior members to increase their ownership in the company.

## How many shares should a company issue?

The company should issue a minimum of one share to every shareholder. There is no limit on the maximum number of shares a company can issue. The number of shares represent the share in profits of the company and also the number of votes when it comes to important decisions. So if your company issues 100 shares, and as a Director and founder, you own 51 shares, which indicates your majority stake in the company. While there are no specific rules, let's look at some factors influencing the number of shares to be issued.

### Advantages of Less number of shares:

• Easy to understand: If a company has three Directors and it issues three shares, it is easy to understand all three have an equal stake in the company.
• Less cash: A small number of shares at a low value will require less capital to be paid by Directors upfront.
• Less liability: If a fewer number of shares are issued at low value in the beginning, this would also mean less liability for the Directors if the company is shut down. Remember, in a Limited Company the Directors liability is limited to their shareholding.

### Advantages of High number of shares:

• Flexibility for shareholders: With a high number of shares, shareholders have the option to sell a portion of their shares without losing their ownership in the company. For example, a shareholder with 100 shares can always sell 25 shares and yet retain a stake in the company; this is not possible if the shareholder has only one share.
• Flexibility for the Company: If the number of shares is high, the company has more flexibility, for instance, if it wants to increase the stake of one shareholder slightly. If three shareholders have 50 shares each, and you issue 10 additional shares to one shareholder, it can marginally increase the stake of the shareholder. But, if the company had one share each, you will have to issue one full share, which can alter the shareholding structure significantly.
• Positive impression: A large number of shares creates a positive impression about the company. All the details of Limited Companies are publicly available on the internet, so a potential client or an investor checking your company may consider it to be large if the number of shares is high.

As you can see, a small number of shares are simple to manage and are low risk. On the other hand, a high number of shares give more flexibility and are ideal for companies with high growth aspirations. You can decide on the number of shares you issue by taking these factors into account. If you are unsure, you should consult other entrepreneurs in your network, or use the services of a consultant.

## What is the nominal value of shares?

When applying for registration of a Limited Company, you will have to include the nominal value of your share. Nominal value means the original value of the share decided by the company. There are no rules around setting a nominal value and it is entirely up to the Directors to decide the nominal value of their shares. Most companies in the UK have a nominal value of £1.

Example 2: If you have a share capital of £3,000, you can set the nominal value as £1 and issue 3,000 shares, or you can set the nominal value as £0.10 and issue 30,000 shares.

## Summary

The basic concept of shares is easy to understand, but there are many related aspects of shares which can be confusing to a new contractor. If you don't make informed decisions about shares and shareholding in the beginning, it could lead to issues in the future. If you want to hire a professional agency, you can check Tempo's company formation services which include assistance on different aspects of shareholding.