Business finance - Share capital and shareholders

Learning Outcomes

This article explains share capital and shareholder rights in UK private limited companies, including:

• Core concepts of share capital and equity financing, different share classes (ordinary, preference, redeemable), and how their rights (voting, dividend, capital) operate in practice
• The capital maintenance regime, creditor protection principles, and the rationale behind restrictions on returning capital to shareholders
• The process and documentation for allotment and issue of shares, director authority (s 550 and s 551 CA 2006), and statutory pre-emption rights (scope, exceptions, and disapplication techniques)
• The distinction between allotment, issue, transfer, redemption, and buyback of shares, with associated Companies House filings and procedural timelines
• How share transfers operate, including stock transfer forms, registration controls under the articles, and stamp duty thresholds and rates
• Share buybacks in private companies: permitted funding routes, shareholder approvals, solvency statement procedures, and post-transaction filings
• The rules on dividends and the distributable profits requirement (s 830 CA 2006), plus director and shareholder liability for unlawful distributions
• How class rights may be varied lawfully, safeguards for affected classes, and typical remedies where procedure is not followed
• Statutory minority shareholder protections, particularly unfair prejudice petitions and derivative claims, and when each remedy is appropriate
• Key differences between private and public companies relevant to equity finance (minimum capital, non‑cash consideration valuation, financial assistance rules, and use of the share premium account)

SQE1 Syllabus

For SQE1, you are required to understand the core principles of equity finance and shareholder rights from a practical standpoint, applying the relevant legal rules to company scenarios, particularly concerning private limited companies, with a focus on the following syllabus points:

• the nature and types of share capital (eg ordinary, preference, redeemable shares) and their associated rights
• the rules governing the allotment and issue of shares, including pre-emption rights
• the principle of capital maintenance and its key exceptions (eg share buybacks, reductions of capital)
• the requirements and procedures for lawful distributions (dividends)
• the distinction between share issue, share transfer, and share buyback
• basic shareholder rights and protections within a company structure.
• variation of class rights (how class rights can be altered and safeguards for affected classes)
• differences between private and public companies on equity finance (minimum capital for plcs, non‑cash consideration rules)
• director authority and proper purpose when allotting shares, and consequences of non-compliance.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. True or False? A private company limited by shares must always first offer new shares to existing shareholders before offering them to outsiders.
2. What is the main principle established in Trevor v Whitworth (1887) regarding share capital?
3. Can a UK private limited company issue shares for less than their nominal value?
4. Which type of shareholder resolution is typically required to approve a company buying back its own shares out of distributable profits?

Introduction

Companies require finance to commence trading, operate, and expand. One primary method of raising finance is through equity, which involves issuing shares to investors who become members (shareholders) of the company. This article focuses on the nature of shares and share capital within private limited companies in England and Wales, the rights and obligations attached to shares, and the critical rules governing the maintenance of a company's capital base, as required by the Companies Act 2006 (CA 2006). Understanding these concepts is essential for advising on company formation, funding, and governance.

A share is personal property representing a bundle of contractual rights against the company, not a proprietary interest in the company’s assets. The assets belong to the corporate entity, separate from the shareholders. This separation underpins both the transferability of shares and limited liability, and informs capital maintenance rules that restrict returning capital to shareholders other than through prescribed procedures.

SHARE CAPITAL

Share capital represents the investment made into a company by its shareholders in return for an ownership stake. It forms a core part of the company's funding and structure.

Key Term: Share Capital
The total nominal value of the shares issued by a company to its members (shareholders).

Share capital is part of equity finance (as distinct from debt finance). Shares are freely transferable items of property (subject to the company’s articles), and each share carries the rights set out in the constitution and/or terms of issue. In UK company law, there is no longer any requirement for a company incorporated under CA 2006 to state an authorised share capital. However, companies incorporated under previous Acts may still have an authorised capital provision in their constitutional documents; if present, it limits the total nominal amount of shares the company may issue until removed or amended.

Types of Share Capital

Several terms describe the status of a company's share capital:

Key Term: Issued Share Capital
The total nominal value of shares that a company has actually allotted (issued) to shareholders.

Key Term: Called-up Share Capital
The portion of the issued share capital that the company has formally requested shareholders to pay.

Key Term: Paid-up Share Capital
The portion of the called-up share capital that shareholders have actually paid to the company. Shares can be fully paid-up or partly paid-up.

Key Term: Nominal Value
A fixed face value assigned to each share (eg £1 or 10p). Shares cannot legally be issued for less than their nominal value (s 580 CA 2006).

Key Term: Share Premium
The amount paid for a share that exceeds its nominal value. This amount must be credited to a separate 'share premium account' (s 610 CA 2006) and is generally treated as capital.

Uncalled share capital is the difference between the company’s issued share capital and called‑up share capital. It represents money the company is entitled to call from shareholders in the future, and is part of the capital creditors rely on.

On use of the share premium account: subject to statutory rules and accounting standards, it may be used for limited capital purposes (eg issuing bonus shares or writing off certain expenses) but not for distributions by way of dividend.

Older companies may still have an “authorised share capital” clause inherited from their pre‑2006 memorandum. It can be removed or increased through the appropriate shareholder resolution to avoid constraining future equity raises.

Classes of Shares

Companies can issue different classes of shares, each carrying different rights, usually defined in the company's articles of association. The most common classes are ordinary and preference shares.

Key Term: Ordinary Share
The most common type of share, typically carrying full voting rights, rights to dividends (if declared), and rights to participate in surplus capital on winding up after other claims are met.

Key Term: Preference Share
A share that grants its holder preferential rights over ordinary shareholders, usually concerning dividends (often a fixed percentage payable before ordinary dividends) and/or return of capital on winding up. Voting rights are often limited.

Key Term: Redeemable Share
A share issued on terms that the company can, or is obliged, to buy it back (redeem it) at a future date or upon certain conditions being met (ss 684-689 CA 2006). These must be issued as redeemable and there must be other non-redeemable shares in issue.

Understanding the different classes and their associated rights (e.g., voting, dividend, capital return) is essential when advising on company structure and shareholder matters. Multiple classes of ordinary shares (often shown as A, B, C shares) can be used to tailor voting and dividend rights, subject to any variation provisions in the articles.

Variation of class rights is strictly regulated. A change that affects the rights themselves (e.g. removing a fixed dividend entitlement) is a variation requiring appropriate class consent and compliance with CA 2006. By contrast, changes that merely affect the enjoyment of a right (such as reducing nominal value where dividends are calculated as a percentage of nominal) may not amount to a variation of the right, though they can affect value materially. The articles often include bespoke safeguards (e.g. requiring class consent for specified alterations), and the statute provides mechanisms for class meetings and court challenge of variations.

Worked Example 1.1

TechStart Ltd has an issued share capital of 100,000 ordinary £1 shares. It issues a further 50,000 ordinary £1 shares to a new investor for £2 per share. What is the company's issued share capital and share premium account balance after this issue?

Answer:
The issued share capital increases by the nominal value of the new shares: 50,000 x £1 = £50,000. The total issued share capital is now £150,000 (150,000 £1 shares). The premium is the excess paid over nominal value: (£2 - £1) x 50,000 shares = £50,000. This £50,000 must be credited to the share premium account.

Worked Example 1.2

Alpha Ltd has 300,000 £1 preference shares carrying a fixed 5% dividend calculated on nominal value, and 600,000 £1 ordinary shares. The company proposes to reduce the nominal value of all preference shares from £1 to 60p, leaving other terms unchanged. Does this constitute a variation of class rights?

Answer:
Reducing the nominal value affects the amount of the fixed dividend because it is calculated as a percentage of nominal value. However, the right itself (a fixed percentage dividend) remains unchanged. This is generally treated as affecting the enjoyment, not a variation of the right. Provided the articles do not require class consent for such a change, it may not amount to a variation under CA 2006. Always cross‑check the articles and consider whether class safeguards apply.

SHAREHOLDERS AND THEIR RIGHTS

Shareholders (members) are the owners of the company. Their ownership interest is represented by the shares they hold.

Basic Rights

Key rights typically associated with shareholding (especially ordinary shares) include:

• Voting Rights: The right to vote at general meetings on shareholder resolutions (e.g., changing the articles, removing a director). Usually, this is one vote per share on a poll vote (s 284 CA 2006).
• Dividend Rights: The right to receive a share of the company's profits when a dividend is declared (subject to the class rights and company performance).
• Information Rights: The right to receive certain company information, such as annual accounts and notice of general meetings.
• Return of Capital: The right to a share of the company's surplus assets upon winding up (liquidation), after all creditors have been paid (priority depends on share class).

The terms “shareholder” and “member” are often used interchangeably for companies with share capital. Membership arises either by subscription on incorporation (deemed agreement to become members) or by entry of the person’s name in the register of members (s 112 CA 2006). A transferee of shares does not become a member until registered.

On voting at meetings, resolutions default to a show of hands (one vote per person present), but a poll (votes per share) can be demanded. Voting via written resolutions (private companies) is counted by total voting rights of eligible members, not just those responding, which can change the outcome compared to a meeting.

Limited Liability

As discussed in earlier materials, a key feature for shareholders in a limited company is limited liability. Their liability for the company's debts is generally limited to any amount unpaid on their shares. If shares are fully paid, the shareholder usually has no further liability to the company's creditors upon insolvency.

Minority Shareholder Protection

While company decisions are often based on majority rule, UK law provides protections for minority shareholders against unfairly prejudicial conduct by the majority (s 994 CA 2006) and allows shareholders to bring derivative claims on behalf of the company in certain circumstances (ss 260-264 CA 2006).

An unfair prejudice petition typically alleges conduct of the company’s affairs that is unfairly prejudicial to a member’s interests (e.g. exclusion from management in quasi‑partnership companies, diversion of business, persistent failure to pay dividends contrary to legitimate expectation). The usual remedy is a buyout order at a fair price; a reasonable early offer to purchase the petitioner’s shares can weigh against granting relief. Derivative claims target wrongs done to the company (e.g. breach of directors’ duties) and require court permission, which includes consideration of whether another remedy (such as an unfair prejudice petition) is more appropriate.

CAPITAL MAINTENANCE

A fundamental principle of UK company law is that a company must maintain its share capital. This is primarily to protect creditors, who rely on the company's capital base as a fund from which debts can be paid.

Key Term: Capital Maintenance
The legal principle that a company's share capital cannot be returned to shareholders except through specific, regulated procedures, ensuring it is preserved primarily for creditors.

The main rules governing capital maintenance include:

• Prohibition on issuing shares at a discount: Shares cannot be issued for less than their nominal value (s 580 CA 2006).
• Restrictions on distributions: Dividends can only be paid out of distributable profits (s 830 CA 2006), not capital.
• Restrictions on share buybacks: A company purchasing its own shares reduces its capital and is strictly regulated (ss 658-737 CA 2006).
• Restrictions on capital reductions: Reducing share capital requires specific procedures involving either court approval or a solvency statement procedure for private companies (ss 641-653 CA 2006).
• Prohibition on financial assistance (Public Companies): Generally, a public company cannot provide financial assistance for the purchase of its own shares (ss 677-683 CA 2006). This prohibition largely does not apply to private companies.

Public companies also face a minimum capital requirement. A plc must not do business or exercise borrowing powers unless the nominal value of its allotted share capital is at least £50,000 and a trading certificate has been issued. Only one quarter of the nominal value and the whole of any premium need be paid up on allotment; nevertheless, the minimum capital rule is widely regarded as offering limited practical creditor protection.

Distributions must be based on “accumulated, realised profits” less “accumulated, realised losses,” with “realised” determined under generally accepted accounting principles. The law looks to the substance of transactions; a payment characterised as something other than a dividend may still be an unlawful distribution if, in substance, it returns capital to shareholders.

Directors who authorise unlawful distributions may be liable to compensate the company if they knew or ought to have known the distribution was unlawful. Members who knew or had reasonable grounds to believe the distribution was unlawful may be required to repay it (s 847 CA 2006). Auditors may also face liability if negligent in failing to detect errors giving rise to unlawful dividends.

Worked Example 1.3

Growth plc made a trading loss last year but has significant accumulated profits from previous years shown in its accounts. Can it lawfully pay a dividend to its shareholders this year?

Answer:
Yes, potentially. Dividends must be paid out of 'distributable profits', defined as accumulated realised profits less accumulated realised losses (s 830 CA 2006). Even with a loss in the current year, if the company's overall accumulated realised profits exceed its accumulated realised losses, a dividend payment may still be lawful.

Worked Example 1.4

Harbor Ltd’s board proposes to sell a subsidiary to a shareholder at a price significantly below market value, intending to “reward loyalty.” The accounts show insufficient distributable profits. Is this likely to breach capital maintenance?

Answer:
Selling an asset at an undervalue to a shareholder can amount, in substance, to a distribution. If there are insufficient distributable profits, such a transaction would be an unlawful return of capital. Courts assess substance over form; the label of “sale” will not prevent a finding that the company has made an unlawful distribution.

SHARE ALLOTMENT AND ISSUE

Allotment is the process by which a company creates new shares and agrees to issue them to specific persons (allottees), usually in return for payment (consideration).

Under CA 2006, allotment occurs when a person acquires the unconditional right to be included in the register of members for the shares (s 558). Issue follows when the person’s name is actually entered into the register of members. This distinction matters for timing and filings: allotment triggers the obligation to file a return of allotment; issue determines membership and voting/dividend entitlement.

Authority to Allot

Directors need authority to allot shares.

• Private company with one class of share: Directors generally have authority under s 550 CA 2006, unless restricted by the articles.
• Other companies (Plcs or private with multiple classes): Directors need authority either from the articles or an ordinary resolution of shareholders (s 551 CA 2006). This authority must state the maximum number of shares and is usually valid for up to 5 years.

Permitting or authorising an allotment without proper authority can be an offence for a director who knowingly contravenes the statutory conditions, although the allotment itself remains valid (s 549).

Directors must also exercise the power to allot for a proper purpose (s 171(b) CA 2006). Using an allotment to dilute a particular shareholder’s voting rights or entrench board control may breach the duty if the dominant purpose is improper.

Allotments cannot be made at a discount to nominal value. For non‑cash consideration, private companies may accept “money or money’s worth.” Valuation of consideration is generally a management judgment; courts intervene only where valuation is colourable or illusory. Public companies face stricter rules: services cannot be accepted as consideration, and non‑cash consideration must be valued by an independent expert qualified to act as auditor, confirming that the value is at least equal to the amount to be treated as paid up (ss 585, 593 CA 2006).

Pre-emption Rights

When issuing new ordinary shares (or securities convertible into ordinary shares) wholly for cash, a company must generally offer them first to existing ordinary shareholders in proportion to their existing holdings (s 561 CA 2006). This is the statutory right of pre-emption.

Key Term: Pre-emption Rights
The right of existing shareholders to have first refusal on the issue of new shares for cash, proportionate to their current shareholding, to prevent dilution of their ownership.

These rights can be disapplied or modified by a special resolution of the shareholders (ss 569-571 CA 2006) or excluded in a private company's articles (s 567 CA 2006). Where pre-emption applies, the offer must be made on terms at least as favourable and include a period (at least 14 days) for acceptance (s 562). Disapplication may be general or specific to a proposed allotment and is often used for small equity raises or where a new strategic investor is to be brought in.

Pre-emption does not apply to non‑cash consideration, many issues of preference shares, bonus issues, or shares allotted under employee share schemes (subject to careful statutory definitions). If pre-emption rights are breached, the allotment remains valid, but the company and any officer in default may be liable to compensate the shareholders who should have been offered the shares.

Worked Example 1.5

Innovate Ltd, a private company with one class of ordinary shares and standard Model Articles, wants to issue 10,000 new ordinary shares for cash to attract a new investor. It currently has 100,000 issued shares held by 5 shareholders equally (20,000 each). What must the directors consider?

Answer:

1. Authority: As it's a private company with one class of share, directors likely have authority under s 550 CA 2006 (assuming articles don't restrict it).
2. Pre-emption: As the shares are ordinary shares issued for cash, statutory pre-emption rights (s 561) apply. The 10,000 new shares must first be offered to the 5 existing shareholders (2,000 shares each).
3. Disapplication: If the company wants to issue directly to the new investor, the shareholders must pass a special resolution to disapply the pre-emption rights (s 569).

Worked Example 1.6

Beta Ltd (private, two classes of shares: voting ordinary; non‑voting ordinary) proposes an allotment of 50,000 non‑voting ordinary shares for cash. Are s 561 pre-emption rights engaged?

Answer:
Statutory pre‑emption applies to “equity securities” which broadly covers ordinary shares or securities convertible into ordinary shares allotted wholly for cash. If the non‑voting ordinary shares are ordinary shares (not preference or non‑equity), pre‑emption will apply unless disapplied or excluded. The company must offer the shares to existing ordinary shareholders proportionately, even though the proposed issue is to a non‑voting class, unless it has effectively excluded or disapplied pre‑emption.

Exam Warning

Pre-emption rights under s 561 CA 2006 apply only to equity securities (mainly ordinary shares) being issued wholly for cash. They do not apply, for example, to issues of non-convertible preference shares or shares issued in exchange for property (non-cash consideration). Always check the type of share and the consideration.

SHARE TRANSFER

Share transfer refers to the sale or gift of existing shares from one shareholder to another. Unlike allotment, this does not involve the company issuing new shares or receiving new capital.

The process typically involves the transferor signing a stock transfer form, which is then given to the transferee (often with the share certificate). The transferee pays stamp duty (if applicable) and sends the form to the company for registration. The transferee becomes a member only when registered in the company’s register of members.

Stamp duty is generally payable at 0.5% of consideration rounded up to the nearest £5, with exemptions for low-value transfers and gifts. Timely submission to HMRC for stamping (or certification of exemption) is essential to avoid penalties.

Directors of private companies usually have the power under the articles (e.g., Model Article 26) to refuse to register a transfer, often without giving reasons. This allows control over who becomes a member. However, directors must exercise this power bona fide in the interests of the company and comply with statutory notice requirements if refusing registration. In a refusal case, legal ownership remains with the transferor, who holds on bare trust for the transferee pending resolution; the transferee may seek rectification of the register if the refusal is improper.

Worked Example 1.7

Cedar Ltd has Model Articles. The board refuses to register a transfer of 10% of voting shares to an external party citing general concerns but provides no detail. What should be considered?

Answer:
Model Article 26 gives directors discretion to refuse registration. They must act in good faith and in the company’s interests, and must notify the transferee promptly with reasons. A blanket refusal without proper consideration or reasons risks challenge. If refusal is not properly justified, the transferee may apply to court for rectification of the register.

SHARE BUYBACKS

A share buyback occurs when a company purchases its own shares from a shareholder. The shares bought back are usually cancelled, reducing the issued share capital.

Key Term: Share Buyback
A transaction where a company repurchases its own shares from existing shareholders.

Buybacks are subject to strict regulation due to the capital maintenance principle:

• The company's articles must not prohibit it (s 690 CA 2006).
• Shares must be fully paid up (s 691 CA 2006).
• Payment must generally be made out of distributable profits or the proceeds of a fresh issue of shares (s 692 CA 2006).
• Private companies have a limited ability to buy back shares using capital, subject to a complex procedure including a solvency statement and special resolution (ss 709-723 CA 2006).
• The buyback contract usually requires approval by an ordinary resolution of shareholders (s 694 CA 2006), with the selling shareholder's votes often disregarded (s 695 CA 2006).

Where a buyback is funded out of profits, a capital redemption reserve may be created to preserve capital. If funded out of capital, private companies must follow the solvency statement route: directors make a statutory solvency statement (supported by auditors’ report), and the company must pass a special resolution approving payment out of capital within seven days of the statement. It must publish the statutory notices (Gazette and either national newspaper or direct to creditors) and wait the statutory period before completing. Post‑completion filings and updating the register are required; the shares are cancelled and the capital redemption reserve adjusted.

Public companies have further restrictions and may hold repurchased shares in treasury subject to strict rules. Private companies generally cancel shares on buyback.

Worked Example 1.8

Delta Ltd proposes to buy back 100,000 £1 fully paid ordinary shares from a departing founder, funding the price partly from distributable profits and the balance from capital. What approvals and steps are required?

Answer:
The buyback contract must be approved by ordinary resolution, excluding the seller’s votes. Funding from distributable profits can be used directly. For the capital element, directors must make a solvency statement (with an auditors’ report annexed), and the company must pass a special resolution approving payment out of capital within seven days of the statement. It must publish the statutory notices (Gazette and either national newspaper or direct to creditors) and wait the statutory period before completing. Post‑completion filings and updating the register are required; the shares are cancelled and the capital redemption reserve adjusted.

Revision Tip

Distinguish clearly between allotment (new shares, company receives funds), transfer (existing shares, shareholder receives funds from another shareholder/donee), and buyback (existing shares, company pays shareholder, shares usually cancelled).

DIVIDENDS

Dividends are the primary way shareholders receive a return on their investment from the company's profits.

Key Term: Dividend
A distribution of a portion of a company's profits to its shareholders, usually in cash, proportionate to their shareholding and share class rights.

Key rules governing dividends:

• Must be paid out of distributable profits (accumulated realised profits less accumulated realised losses) (s 830 CA 2006).
• Directors usually recommend a final dividend, which must then be declared (approved) by shareholders via ordinary resolution (Model Article 30). Directors can often pay interim dividends without shareholder approval.
• Shareholders receiving an unlawful dividend (knowing or having reasonable grounds to believe it was unlawful) may be liable to repay it (s 847 CA 2006).

The company should ensure up-to-date accounts support the availability of distributable profits, and the board minutes and shareholder resolutions are properly recorded. Different classes may have different dividend rights (e.g. fixed preference dividends or waived rights), and dividends must comply with those rights.

Worked Example 1.9

Orion Ltd wishes to pay a final dividend of £250,000. The latest accounts show accumulated realised profits of £600,000 and accumulated realised losses of £400,000. Can a £250,000 dividend be lawfully paid?

Answer:
Distributable profits are £600,000 less £400,000 = £200,000. A final dividend of £250,000 would exceed distributable profits and be unlawful. The company could pay up to £200,000, subject to proper declaration and any class rights.

Summary

Table: Key Equity Finance Concepts

Key Point Checklist

This article has covered the following key knowledge points:

• Share capital is the equity funding raised from shareholders, categorised by its status (issued, called-up, paid-up). The share premium account records amounts paid over nominal value and is generally treated as capital.
• Companies can issue different classes of shares (ordinary, preference, redeemable) with distinct rights defined in the articles. Altering class rights is strictly controlled; safeguards include class consent and possible court challenge.
• Shareholders possess key rights including voting, dividends, information access, and pre-emption rights, alongside limited liability. Membership depends on entry in the register of members.
• The capital maintenance doctrine restricts returning capital to shareholders, impacting dividends, buybacks, and capital reductions (via court or solvency statement route). Public companies face additional rules (minimum capital, financial assistance prohibitions, valuation of non‑cash consideration).
• Allotting new shares requires director authority (s 550/551 CA 2006) and adherence to pre-emption rights (s 561 CA 2006) unless validly disapplied/excluded. Shares cannot be allotted at a discount to nominal value.
• Share transfers involve existing shares changing hands between shareholders, with process and stamp duty requirements. Directors in private companies often have discretion to refuse registration, subject to good faith and statutory notice.
• Share buybacks are strictly regulated, usually requiring funding from distributable profits and shareholder approval (OR), with additional solvency statement and special resolution requirements when funded from capital.
• Dividends must be paid only from distributable profits (s 830 CA 2006). Directors and members may face liability for unlawful distributions depending on knowledge and care.

Key Terms and Concepts

• Share Capital
• Issued Share Capital
• Called-up Share Capital
• Paid-up Share Capital
• Nominal Value
• Share Premium
• Ordinary Share
• Preference Share
• Redeemable Share
• Capital Maintenance
• Pre-emption Rights
• Share Buyback
• Dividend