The pros and cons of share capital

The size and shape of share capital vary between companies, depending on their funding requirements, stage of business development, the policy of the company owners, and a multitude of other factors. We will take a look at the pros and cons of share capital and also explain the procedure for increasing or decreasing it. of your company. But first, let’s consider what it means.

What is share capital?

A limited company must assign a ‘nominal’ value to each of its shares upon incorporation – for example, £1.00 per share. This nominal value, also known as the par value, represents the limited liability of the company’s members. It denotes the sum that shareholders must pay for each of their shares if the company be wound up.

The share capital of a company refers to the total nominal value of all shares that have been issued by a company. You will sometimes see this referred to as the ‘aggregate nominal capital’. So, for example, if a company has 100 shares at a nominal value of £1.00 each, its share capital is £100.

The value of the company cannot be determined by reference to its share capital. Instead, it is necessary to consider the current market value of each share, which will generally be higher than the nominal value. The difference between the nominal value and the market value is known as the ‘share premium.’

In the context of this blog – we are discussing the merits of living with a large share capital from the point of incorporation, or later by choosing to utilise it as a way to develop a business, rather than using other vehicles such as business loans.

What are the advantages of share capital?

There are occasions where it may be necessary to demonstrate a certain level of share capital. For example, some lenders and creditors might assess the creditworthiness of a company by taking into consideration the size of its share capital. Also, certain trade organisations sometimes apply a membership requirement of a minimum size of share capital.

A larger share capital can have the effect of making a company appear more financially secure. Investors may be more inclined to back a business with a large paid-up share capital. However, appearances can be deceptive, so increasing it will not necessarily make a company a safer bet in the eyes of experienced investors.

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Some companies will decide to increase their share capital as an alternative to taking out a loan. The advantage is, there are no interest payments. Although dividends are often paid to shareholders, this depends on the success of the business. There is generally no obligation to pay dividends.

Furthermore, there are no stipulations attached to capital raised from shares, whereas a bank loan can come with various restrictions. For example, it might only be available to use for a specified purpose agreed in advance. Overall, using share capital instead of taking out a business loan can offer a company more financial flexibility.

What are the disadvantages of share capital?

Increasing a company’s share capital can lead to the shares of existing shareholders becoming diluted. This can affect both dividend payouts and voting rights.

Although an ordinary resolution is required to allot new shares (i.e. the majority of shareholders will need to approve an increase), this can leave a minority of shareholders discontent with the change in circumstances, which can create problems for the future.

In general, increasing share capital through the allotment of new shares will reduce the level of control of the founders, because the creation of more shares usually means that more power is given away.

If there are multiple principal shareholders and a new significant shareholder buys up enough newly created shares, they may be able to form an alliance with an existing principal shareholder and change the balance of power. At the extreme end, a company that issues too many new shares can become vulnerable to takeover by a competitor.

Even if there is no need to allot new shares, a larger share capital can create more risk for the existing shareholders. For example, if the nominal value of each share is set at £1,000 rather than £1, each shareholder’s limited liability for the company’s debts would be equal to £1,000 per share owned, as opposed to just £1 per share.

This may look good to outside investors because it demonstrates that shareholders have invested a substantial amount of their own money in the future success of the business. However, if the company runs into financial difficulty and gets wound up, each shareholder will lose more of their own money.

Now that we have walked through the pros and cons, how do you increase it or decrease it?

How to increase share capital

To increase share capital in a company, it is usually necessary to issue new shares. This process is known as an ordinary allotment of shares.

The basic procedure would normally require the existing shareholders to pass a special resolution, consenting to the issuance and waiving their right to pre-emption on the new shares.

This requires a majority of at least 75% of the votes to be cast in favour of the resolution at a general meeting of shareholders. Alternatively, this can be carried out by written resolution, which removes the need to hold a general meeting.

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The company and its directors are then usually allowed to issue the shares. However, these procedures may differ from company to company.

Within one month of the allotment of shares, form SH01 must be filed with Companies House to provide notice of the procedure having taken place. This form includes a statement of capital, which must be filled out to reflect the company’s issued capital following the allotment.

Finally, the register of members needs to be updated, and new share certificates should be issued within two months. It may also be necessary to update the register of people with significant control (PSC register).

How to reduce share capital

There are many different reasons for decreasing the share capital of a company, but the overall effect will be to transfer funds from the company back to its shareholders. It is worth remembering there are strict rules on this matter. If you are unsure of them, you should seek professional advice.

In general terms, a reduction in share capital is usually achieved with a special resolution supported by a solvency statement of the directors.

Within 15 days of passing the resolution, form SH19 needs to be filed with Companies House, along with:

• a copy of the shareholders’ special resolution
• a directors’ statement of solvency
• and a directors’ statement

And remember, a reduction of capital carried out in this way is only effective when Companies House processes the SH19 Form.

So, there you have it

We have provided an introduction to share capital, explaining the ways in which it can impact a company and its shareholders. We also discussed using share capital as a means of developing your business, as well as the procedures you need to follow to increase and decrease it.

If you have any questions, please leave them in the comments section below. In the meantime, why not browse the 1st Formations Blog for more advice on limited companies, reporting requirements, and tax obligations.