Scrip dividends: definition, purpose, pros and cons, and issuing them

A scrip dividend is a type of dividend that gives shareholders the option to receive extra shares rather than cash payments. They provide a flexible solution for companies to raise capital and reward shareholders while retaining cash in the business. Scrip dividends are also known as ‘stock dividends’ or ‘bonus issues of shares’.

This post provides a brief overview of scrip dividends. We discuss their purpose, the potential pros and cons for companies and shareholders, and the steps required to issue this type of dividend.  

Understanding scrip dividends in a limited company 

A ‘scrip’ is any document used as a substitute or alternative to legal tender. A scrip dividend is an alternative form of dividend payment that provides shareholders with additional shares in a company instead of the usual cash dividend payment.

Historically, they were used to reward investors when a company was short on distributable cash or experiencing financial difficulties. 

Companies nowadays also issue scrip dividends to raise capital, fund expansion plans, facilitate mergers and acquisitions, cater to the preferences of different investors, and strengthen their relationships with valuable shareholders. 

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When a shareholder elects to take all or part of their dividend as extra shares, they receive fully paid or discounted bonus shares in proportion to their existing holdings. The value of the shares is equal to the forgone cash dividend alternative. 

Scrip dividends are usually structured as newly issued shares rather than existing shares. Sometimes, however, they may involve the transfer of shares held in treasury (treasury shares). 

Advantages of issuing scrip dividends 

Issuing scrip dividends can provide several benefits for both companies and shareholders. We outline the most notable ones below:

1. Benefits for companies

• A way to reward existing shareholders without depleting cash reserves. 
• It can help improve the company’s cash flow position.
• Ability to retain cash reserves in the business. The company can then use this money to fund projects and future growth, pay down debt, or reinvest in the business in some other way. 
• Option for greater financial flexibility during times of economic uncertainty or when the company has a shortage of liquid funds.
• It can enhance financial stability and creditworthiness by strengthening the company’s equity position on its balance sheet.
• Different shareholders’ interests and preferences can be accommodated.

2. Benefits for shareholders

• Gives shareholders the choice to receive additional shares, cash dividends, or a combination of both.
• Companies sometimes offer enhanced scrip dividends with a share value that exceeds the cash dividend value to encourage take-up. 
• Opportunity to increase their ownership stake in a company for no cost or at a discounted price.
• A cost-effective way to compound their investment and maximise returns over the long term.
• Ability to diversify their investment portfolio without incurring additional cash outlays. 
• Scrip dividends are exempt from the 0.5% Stamp Duty tax charge when purchasing shares electronically through the ‘CREST’ system or using a stock transfer form.

Disadvantages of issuing scrip dividends

While issuing this type of dividend offers many benefits, companies and shareholders should also be aware of the potential drawbacks:

1. Drawbacks for companies 

• Unless scrip dividends are offered pro-rata only to existing shareholders (rather than new investors), there is a potential risk of share dilution. This will reduce existing shareholders’ proportion of ownership and earnings per share.
• If the share value increases, the company will have to pay higher dividends than the forgone cash dividend.
• This may give the impression that the company is in financial difficulty or does not have sufficient cash to pay dividends in the usual way.
• Reduces earnings per share due to a higher number of shares in issue.
• With more shares in issue, the company will have an increased administrative burden when declaring and issuing future dividends. 

2. Drawbacks for shareholders 

• If a shareholder relies on dividend income, receiving extra shares rather than a cash payment won’t meet their immediate financial needs.
• Scrip dividends are reported and taxed through Self Assessment in the same way as cash dividends. They are generally subject to dividend tax based on the cash equivalent value of the shares. 
• Depending on the company’s future performance, the value of the additional shares may decrease below what the shareholder would have otherwise received as a cash dividend.  

How to issue scrip dividends in a limited company 

Any company wishing to offer scrip dividends to shareholders should include clear guidelines and a specified procedure in its articles of association and shareholders’ agreement. 

You should refer to these documents before issuing scrip dividends. Check the rules and restrictions on bonus shares and whether pre-emption rights on share allotments or transfers exist. 

Typically, however, the procedure for issuing scrip dividends in a UK company limited by shares will be as follows:

Step 1

The directors will hold a board meeting to consider the company’s financial position and future plans. They will then propose an allotment of new shares or transfer of treasury shares as scrip dividends. Meeting minutes must be taken.

Step 2

The shareholders will pass an ordinary resolution to approve the share allotment or transfers and the proposed scrip dividends at a general meeting or by written resolution. Alternatively, they may modify the board’s dividend proposal. Meeting minutes must be taken if a general meeting is held. 

Step 3

The directors will give eligible shareholders the option to receive cash dividends, additional shares in proportion to their current holdings, or a combination of both. 

Step 4

Upon issuing scrip dividends, the directors must provide share certificates and update the company’s register of members accordingly. 

Step 5

Within one month of issuing the new shares, the directors must file form ‘SH01: Return of allotment of shares’ with Companies House. Alternatively, if the scrip dividends involve the transfer of treasury shares, the directors must instead file form ‘SH04: Notice of sale or transfer of treasury shares’ with Companies House. 

Thanks for reading

Scrip dividends can be a cost-effective tool for companies and provide additional investment opportunities for existing shareholders as an alternative to cash dividends.

However, before issuing scrip dividends to shareholders or electing to take additional shares instead of cash dividends, companies and shareholders should seek professional guidance from an accountant or tax advisor.

If you require assistance with an allotment or transfer of shares in preparation for issuing scrip dividends, our London-based team can help. We offer an Issue of Shares Service and a Transfer of Shares Service, both of which include the preparation and filing of the necessary documentation. 

Please feel free to comment below if you have any questions. For more limited company guidance and small business advice, explore the 1st Formations Blog.