Share capital

Introduction to Share Capital

Welcome! In this chapter, we are going to explore the backbone of company finance: Share Capital. Think of share capital as the "fuel" that helps a company engine run. When people invest money in a company, they receive "shares" in return, which represents their slice of ownership. Understanding this is crucial because it defines who owns the company, who gets the profits, and how the company is protected from going bust. Don't worry if some of the legal terms feel heavy—we’ll break them down together using simple everyday examples!

1. What is a Share?

A share is a bundle of rights and obligations. When you buy a share, you aren't just giving money; you are entering into a contract with the company. Did you know? A share is technically "personal property," meaning you can sell it or leave it to someone in your will, just like a car or a watch.

Nominal Value vs. Market Value

It is very important to distinguish between these two values:
1. Nominal Value (or Par Value): This is the fixed "face value" of the share set when the company is formed (e.g., $1.00). It stays the same regardless of how well the company is doing.
\n2. Market Value: This is what the share is actually worth on the street. If the company is successful, a share with a \( \$1.00 \) nominal value might sell for \( \$50.00 \).

Quick Review: The Issued Share Capital is the total nominal value of all shares currently held by shareholders. For example, if a company has issued 1,000 shares of \( \$1.00 \) each, the issued share capital is \( \$1,000 \).

2. Types of Shares

Not all shares are created equal! Companies can create different "classes" of shares to suit different investors. Imagine a VIP section at a concert vs. standard seating—both get you into the show, but the perks are different.

Ordinary Shares

These are the most common. They are often called "Equity Shares."
\n- Voting: Usually carry one vote per share.
\n- Dividends: Shareholders get paid only after everyone else has been paid.
\n- Risk: If the company fails, these shareholders are the last to get any money back. They take the biggest risk but get the biggest rewards if the company grows.

Preference Shares

These are "safer" and act a bit like a loan.
\n- Dividends: Usually a fixed percentage (e.g., a 5% preference share).
\n- Priority: They get their dividends before ordinary shareholders.
\n- Voting: Often, they have no voting rights unless their dividends are in arrears (unpaid).

Key Takeaway: Ordinary shares are for those who want control and growth; Preference shares are for those who want steady, priority income.

3. Issuing Shares (Allotment)

When a company gives out new shares, we call this allotment. It is the process where people acquire the unconditional right to be included in the register of members.

The Authority to Allot

In a Private Limited Company (Ltd) with only one class of shares, directors generally have the power to issue shares whenever they like. However, in Public Companies (PLCs) or companies with multiple classes of shares, directors usually need formal permission from the shareholders (via an ordinary resolution) to issue new shares.

Pre-emption Rights (Rights of First Refusal)

If a company wants to issue new "equity" shares for cash, they must first offer them to existing shareholders in proportion to their current holdings.
\nExample: If you own 10% of a company, and they want to issue new shares, they must offer you 10% of that new batch first. This prevents your ownership from being "diluted" without your consent.

Bonus Issues and Rights Issues

1. Bonus Issue: The company gives "free" shares to existing members by turning its kept profits (reserves) into share capital. No cash changes hands.
\n2. Rights Issue: The company offers existing shareholders the chance to buy new shares, usually at a discounted price compared to the market value. This is a way for companies to raise fresh cash quickly.

4. Variation of Class Rights

If a company wants to change the "rules" for a specific group of shares (e.g., taking away the voting rights of preference shareholders), this is called a variation of class rights.

To do this, the company must follow the rules in its Articles of Association. If the Articles are silent, the law (Companies Act 2006) says you need:
\n- Written consent from 75% of the holders of that class, OR
\n- A Special Resolution passed at a separate meeting of that class of shareholders.

Protection for the Minority: If you own at least 15% of the shares in that class and you didn't vote for the change, you can apply to the Court to have the variation cancelled if you can prove it is "unfairly prejudicial." You must do this within 21 days!

5. Capital Maintenance

This is a big legal concept. The basic rule is: A company must maintain its share capital for the sake of its creditors.

Because shareholders have "limited liability," creditors (people the company owes money to) can only look at the company's assets to get paid. If shareholders were allowed to just take their capital back whenever they wanted, there would be nothing left for creditors.

Key Rules of Capital Maintenance:

- No Dividends from Capital: Dividends can only be paid out of distributable profits (accumulated realized profits minus accumulated realized losses). You cannot pay dividends out of the money shareholders originally invested.
\n- Issuing at a Discount: A company is strictly forbidden from issuing shares for less than their nominal value. If a \( \$1.00 \) share is issued for \( 80 \) cents, the shareholder must eventually pay the remaining \( 20 \) cents plus interest.
- Public Companies (PLC) Rule: If a PLC’s net assets fall to half (50%) or less of its called-up share capital, the directors must call an extraordinary general meeting to discuss what to do. This is a "serious loss of capital" warning.

Analogy: Imagine the share capital is a "buffer fund" that stays inside the company's bank account to make sure the people who lend the company money (like banks or suppliers) have a safety net.

6. Transfer of Shares

One of the best things about a company is that owners can change without the business stopping.
- Public Companies: Shares are usually traded on a stock exchange (like the London Stock Exchange) and transferred electronically (CREST).
- Private Companies: Transfers are done using a Stock Transfer Form. The directors of a private company often have the power to refuse to register a transfer (e.g., they might not want a competitor to become a shareholder), but they must give a reason for the refusal within two months.

Summary Quick-Check

1. Can a company issue a \( \$1.00 \) share for \( \$0.90 \)?
No. This is "issuing at a discount" and is illegal.
2. What is a Rights Issue?
An offer to existing shareholders to buy new shares, usually at a discount, to raise cash.
3. Who gets paid first in a liquidation?
Creditors first, then Preference shareholders, and finally Ordinary shareholders (if anything is left!).
4. What percentage is needed to object to a variation of rights in court?
At least 15% of the shares of that class.

Keep going! You're doing great. Understanding share capital is the hardest part of corporate finance—once you've mastered this, the rest of the section on "Capital and Financing" will feel much more manageable!