Classes of Share

[OGgy21]

What is the purpose of having different classes of shares if they appear to have the same rights attributed to each?

There are ordinary a shares, b shares, c shares and d shares, however they all have the same prescribed particulars 'full divi, voting and distribution rights, non redeemable, dividends declared and distributed'.

If this is the case why not just all be ordinary shares?

 

[Nico Albrecht]

It's common for companies to have different classes of shares, each of them conferring different rights to shareholders, such as voting power and the right to dividends or capital. Wouldn't be uncommon that the wifey / partner having a small percentage b shares to claim some dividends at a certain amount for tax reasons not affecting the distribution of a shares dividend payouts.

 

[eteb3]

There are ordinary a shares, b shares, c shares and d shares, however they all have the same prescribed particulars

When declaring a dividend, all shares (of a given class) have to rank pari passu - ie, equally. In the default case (ie, all shares are ordinary shares of the same class - and precisely because they're all the same class, there's no need to give it a class name at all), all shareholders participate equally in any division of the profits (=dividend), proportionate to their shareholding.

With 'alphabet shares', in any year the shareholders can declare a separate dividend for the A shares and for the B shares, etc. A might get 20% of the profit one year and B 80%, regardless of their 'real' proportions of ownership of the company; then the next year it can be a different ratio; or maybe A gets a dividend while B doesn't at all.

This would be a company acting as a 'quasi partnership' (although saying that, alphabet shares are not a strictly necessary feature of a q-p).

A different solution is to use dividend waivers, but they are complex both tax-wise and legally.

 

[OGgy21]

ETEB, thanks for this, so the different alphabet shares denote different dividend entitlement (as i thought was the case - however i thought it would have to be mentioned in the prescribed particulars - i.e. class a shares would be entitled to the first 75% of the dividends from profits, class b entitled to the next 25% etc).

Am i right in saying therefore that each type of shareholder would receive these dividends in the proportion to their shareholding too - ie if class a shareholders were entitled to the first 75% of profits as dividends and there were two class a shareholders (one had 60% of the class a and the other 40%, it would be split 60/40?

 

[eteb3]

i thought it would have to be mentioned in the prescribed particulars - i.e. class a shares would be entitled to the first 75% of the dividends from profits, class b entitled to the next 25% etc

You could mandate that in the articles if you want. But the whole point of the arrangement is to allow more flexibility than the articles and general company law allow for: company law is highly rigid and formalised. By contrast a partnership at the end of the year can apportion the profits however they like: alphabet shares are trying to replicate something of that flexibility.

if class a shareholders were entitled to the first 75% of profits as dividends...

This is not relevant to your case, for reasons of the flexibility mentioned above.

...and there were two class A shareholders (one had 60% of the class a and the other 40%), it would be split 60/40?

Yes, that's right: while the total dividend can be distributed between the various share classes in whatever proportions the members agree, within each share class all members must be treated pari passu. This is why, just as changes in company articles need a 75% majority of all shareholders, changes in rights of (say) Class A shares require a 75% majority of Class A shareholders to agree them.

 

[OGgy21]

that's interesting re. your last sentence, i would have presumed it would have required 75% of all shareholders. Yes i understand that re. the second paragraph, it was a example more than anything.

Of course shareholders can require a greater majority than 75% if stated in the articles or sh agreement, but not less.

is this also the case with ordinary resolutions i.e. can they change it to say 60% instead of 50%? Albeit unlikely to ever arise but curious

 

[eteb3]

is this also the case with ordinary resolutions i.e. can they change it to say 60% instead of 50%? Albeit unlikely to ever arise but curious

The articles can be very flexible by and large. There are a few things that the Companies Act requires to be passed by given majorities: eg, a minimum 75% majority to change the articles, and I think (not sure) that the simple majority to remove a director can't be increased.

But if CA2006 doesn't require a particular threshold, the articles can say whatever the members like. They can even require unanimity (though anything more than 75% majority needs to be notified on the file as 'provision for entrenchment').

By tinkering with the rights of different shares on particular types of resolution, you can even, practically speaking, fudge the majority below or above what CA2006 stipulates. The important words in the law are (eg)

passed by members representing not less than 75% of the total voting rights of eligible members​

Say we have A and B shares. Founder could have one A Share which has full voting rights; all other shares are B shares which have unrestricted rights except on a vote to remove a director. Even if 51% of the shares vote to remove the director, there is only one A Share that is eligible to vote on that resolution. Founder rolls another cigar and wonders why it was only he that took legal advice.

 

[OGgy21]

am i correct in saying then that in a sh agreement you could require a change of the articles to require unanimity as a special res as it is 'not less than 75%' under s283?

i think you're right re. removal of director as CA states it must be done by ordinary resolution which is defined as a simple majority. As above however, a special res is defined as 'not less than 75%' so technically this could be changed to a higher threshold

 

[eteb3]

Sh agreements are more or less beyond me but afaik all bets are off: you can agree whatever you like, and can in practice defeat the articles - because it's a matter of contract law and runs alongside, not combined with, company law.

So, eg, you could agree that a change of articles will follow a simple majority of shareholders in a personal vote (ie, under the sh agreement), with the 49% losers required to cast their ballots in favour of the change in a subsequent company vote (ie, under the articles). If they reneged, the articles still wouldn't change (because you can't remove a member's statutory rights), but the victorious 51% would have a claim in contract against them for damages.

Or equally in your scenario: all members agree that they will not cast their ballots in favour of any change in the articles unless all members have previously agreed to them.

But not 100% sure on this - anyone else following, I'd love to be put right/confirmed.

 

[OGgy21]

that has gone completely over my head!

 

[WaveJumper]

My advice ......... keep it simple

 

[Clinton]

There is one risk with alphabet shares that's often forgotten / ignored. Part of the risk has only started recently so practitioners may not actually be aware of it.

When disposing of a company, shareholders are entitled to a reduced rate of CGT on their gains. This is called Entrepreneurs Relief. It's worth a considerable sum of money so well worth taking advantage of (as long as it exists).

However, additional requirements were added in 2018. To qualify for ER the individual is required to have beneficial entitlement to

at least 5% of the profits available for distribution to equity holders; and
at least 5% of the assets distributed to equity holders on a winding up.

That "beneficial entitlement" is trickier than it sounds. I would advise anyone considering going down the alphabet shares route (or who already has an alphabet share structure) to have a chat with their accountant about this.

Even if you're not planning on selling your company, you still need to be aware of this. Like with all exit planning, this kind of stuff doesn't become relevant till you choose to sell or ... you die / get terminally ill / are otherwise forced to stop working / need to liquidate the company. And then it's too late to make changes!

 

[eteb3]

@Oggy, "beneficial entitlement" would probably include, among other things, entitlement under the shareholder's agreement. What the articles give you is "legal entitlement", which may be different.

Eg, I own half the plain vanilla shares in a company. Legally I'm entitled to 50% of the profits and assets. But under the sh agreement, I've agreed to give half my legal entitlement to the other shareholder. I therefore have only 25% beneficial entitlement.

This is another example of how the articles and the sh agreement work in parallel, not together. The company must pay a dividend only to the legal shareholder. What that shareholder has agreed to do with it is a matter of contract between him and the person he's got a contract with, and the internal mechanics of the company are left untouched.

 

[The Resolver]

Interesting thread

Let me start by making a small correction to eteb3’s use of the term “quasi partnership”. What he describes would not make a company a QP. A QP is how a court might characterise a limited company whose main shareholders have a personal relationship of trust between them and an underlying understanding, not perhaps in writing, to work and make decisions together. You can’t create a QP by using such terms. It exists or not according to, ultimately whether a court might interpret it as such.

But you are correct that contract based agreements between the shareholders might open up options for enforcement ,For example, when two people set up a company say 60/40 in circumstances that make it possible for a court to classify it as a QP (agreed to always work together in running the company) then if the 60% votes the 40% off the Board , the latter may have a good case that, whilst he cannot avoid being removed as a director, he has potentially a breach of contract claim or indeed grounds to argue ‘unfair prejudice’ under s994 CA 2006.


Turning to the direct issue of alphabet shares, yes a Shareholders Agreement could well create contractual rights over the threshold for removal of a director that, whilst not preventing action being taken in accordance with the Articles /Companies Act , create options to claim compensation for loss/damage caused by the breach (failure to honour higher voting level.)


As to “beneficial ownership”.its not exactly as Clinton describes it but is the right to enjoy the benefits and rights in law (as opposed to rights agreed under contract) connected to the ownership of the shares). This will generally not be a concern to most people since it applies only to those who has acquired shares in limited circumstances under which some other person may have the right to beneficial interest, eg when shares are put in the name of X but with X acting on behalf of Y, who paid the price and is the real owner. Similarly you may not be the beneficial owner if some condition precedent to your acquiring the shares has not yet been satisfied, eg payment. So A can agree to sell shares to B but beneficial ownership does not pass until payment has been made.

 

[Clinton]

As to “beneficial ownership”.its not exactly as Clinton describes it but is the right to enjoy the benefits and rights in law (as opposed to rights agreed under contract) ...

Beneficial ownership is something different altogether. The OECD, for one, has plenty to say on that topic.

The term I used was "beneficial entitlement" - to avoid confusion - and that's in connection with calculating eligibility for Entrepreneurs' Relief.

 

[The Resolver]

Oops - thanks for pointing out, Clinton - bit of conflation going on in my head! Yes i see the distinction although I would disagree that BO is "something different altogether" since the 5%BE is simply setting the bar higher than just 5% BO - but you still have to have 5%BO. If you do not have BO to 5% of nominal value you cannot anyway claim ETR but if you do have 5%BO you may still be disentitled to ETR if you have reached some arrangement whereby you are restricted to earning dividends less than 5%.

 

[Clinton]

No problem.

But I do think "beneficial ownership" is a whole different kettle of fish; especially in the context of the wider worldwide conversations around base erosion & profit shifting. Beneficial ownership is a concept central to preventing BEPS but one that lacks the common international definition it needs (though the OECD has their own interpretation which has been used for a while now to frustrate treaty shopping).

In the context of one small business however, yes, the two are very close in meaning except that beneficial entitlement has, as you put it, "a higher bar".

 

[The Resolver]

Googling around to improve my knowledge I came across this accountant's site which, in covering the 2018 rule does so under a paragraph headed "Changes to beneficial ownership requirements" .

 

[Clinton]

paragraph headed "Changes to beneficial ownership requirements" .

They do call it that in the heading but later on in the article they do use the correct nomenclature so I'll let them off

the 2018 rule

It's the 2019 rule to be fair, not 2018. Apologies. The date in my original post was a mistype, the change to ER was effective from 2019. But let's have a longer chat about beneficial ownership the next time we have a chat, if you're interested. I've done some offshore stuff so I had to get familiar with all kinds of nonsense around beneficial ownership (for my own benefit rather than to help clients).

 

[eteb3]

that has gone completely over my head!

@OGgy21 , I know how you feel

 

[Clinton]

My apologies, the conversation got a bit skewed.

OP, ignore everything about base erosion and treaty shopping; that's all irrelevant even in relation to exit planning / eventual disposal of shares (of a UK Ltd company).

With respect beneficial ownership vs beneficial entitlement - you could see it (roughly) as ownership of a company vs rights to dividends in the company. In other words, ownership can be separated from rights to profit via the use of alphabet shares. And all that was covered brilliantly by @eteb3

 

[The Resolver]

But let's have a longer chat about beneficial ownership the next time we have a chat, if you're interested. I've done some offshore stuff so I had to get familiar with all kinds of nonsense around beneficial ownership (for my own benefit rather than to help clients).

Sure, thanks

 

[Clinton]

I'm going to be cheeky and try posting an ad in here. Mods, delete if you wish.

People reading this thread likely have an interest in finding out about alphabet shares or already know a lot about them. If you're the latter, please get in touch. I've been wanting to post on my site a really detailed article covering this topic from all angles. Are you the person to write it for me? (Please don't post in here as that could derail this thread, send me a DM instead. Thanks)

@OGgy21 , sorry for the pitch invasion. Back to the main topic, everyone.