You might be about to start up in business with a friend, or you may already be running a successful business and are thinking about issuing some shares to one of your key employees to retain them or keep them incentivised. Before you do, think, what are the consequences? In this blog post we look at some of the things to consider when issuing shares.
1. Do I have authority to allot the shares?
Directors of a company must have authority from shareholders to allot new shares. For new companies, this authority is usually contained in the articles of association and will last for a period of up to five years. The directors can also be authorised to allot new shares by the shareholders passing an ordinary resolution.
2. Do any pre-emption rights apply?
The Companies Act 2006 states that if any new shares are to be issued for cash, then the new shares must first be offered to the existing shareholders in proportion to their shareholdings. If you are planning on issuing new shares in any other way, then these pre-emption rights need to be disapplied.
The articles of association of many private companies already disapply these statutory pre-emption rights. However, they may include their own detailed pre-emption rights. If the articles of association contain pre-emption rights, you may need to obtain a waiver from the company’s shareholders, under which they agree to waive their pre-emption rights in connection with the new share issue.
3. If a shareholder leaves the company, how do I get his shares back?
This is one of the questions that causes the most headaches for the continuing directors and shareholders of a company.
In short, the answer is, it depends on what it says in your articles of association or your shareholders’ agreement (if you have one).
The only way to ensure that a departing shareholder’s shares are transferred by them when they leave the business is to include specific provisions in the company’s articles of association or in a shareholders’ agreement. These provisions are known as ‘leaver’ provisions, and will ensure that the continuing directors and shareholders have the ability to take the shares off a departing shareholder in various circumstances, such as the resignation or dismissal of that shareholder.
Typically, ‘leaver’ provisions will also set out the price that is to be paid for the departing shareholder’s shares. A departing shareholder may receive less value for his shares where is he a ‘bad leaver’ (for example where he resigns or is dismissed), than where he is a ‘good leaver’ (for example where he dies, or becomes physically or mentally incapable of continuing in his role).
If there are no express ‘leaver’ provisions in the articles or a shareholders’ agreement, the departing shareholder will continue to hold their shares until they decide to sell and there is no way to force them to give up their shares despite their lack of on-going involvement with the company.
4. If a shareholder dies, how do I get his shares back?
The answer is, in the same way as set out above. Death is a typical ‘good leaver’ scenario, where a shareholder has ceased to be an employee through no fault of their own. In this situation, the estate of the deceased shareholder usually receives the fair value for the shares, with no discounts applied for minority shareholdings or any restrictions on the transferability of the shares.
Where the articles of association include ‘good leaver/bad leaver’ provisions, they will usually allow the company to buy back the shares from the estate of a deceased shareholder, rather than transferring them to the other shareholders. But what if the company does not have the funds available to it to buy the shares? To prepare for this, a company can take out an insurance policy which will provide it with the funds to buy the shares in the event of the death of a shareholder.
5. What practical things do I need to do if I’m issuing shares to an employee?
You will need to:
- pass a resolution, or get an appropriate waiver, to disapply any relevant pre-emption rights;
- hold a board meeting to approve the allotment and issue of the shares;
- issue the employee with a share certificate;
- file a copy of any resolution disapplying the statutory pre-emption rights at Companies House;
- file a form SH01 at Companies House recording the allotment and issue of the shares; and
- write up the company’s statutory books to record the issue of the new shares.
You may also need to consider amending the company’s articles of association (for example, to include the ‘leaver’ provisions discussed above). And, finally, don’t forget our old friend, tax: can you take advantage of any of the tax efficiencies available if the shares are issued via some form of employee’s share scheme? Should the employee enter into a ‘s431 election’ with the company to improve their tax position on any subsequent sale?