The size of share capital varies between companies depending on their funding requirements, stage of business development, policy of the company owners and a multitude of other factors. We will take a look at the pros and cons of a large share capital and explain how to change the share capital of a company. But first let’s consider the meaning of share capital.
What is share capital?
A limited company (which is limited by shares as opposed to limited by guarantee) must assign a ‘nominal’ value to each of its shares upon incorporation, e.g. £1 or £0.01. This nominal value, also known as the par value, represents the ‘limited liability’ of company members. It denotes the sum that shareholders must pay for each share they own, should the company be wound up.
The share capital of a company refers to the total nominal value of all shares which have been issued by a company. So, for example, if 100 shares at a nominal value of £1 each have been issued by the company, its share capital will be £100.
The value of the company cannot be determined by reference to its share capital. Instead, it is necessary to consider the current market value of each share. which will generally be higher than the nominal value. The difference between the nominal value and the market value is known as the ‘share premium’.
Why would I increase the share capital?
All companies must issue at least one share to form a company limited by shares. For example, a company with just one shareholder/owner (who will often also be the sole director) can be incorporated with just a single share of £1. This is fine for a small company which has sufficient funding and does not need to trade equity in the business in exchange for external investment or resources.
However, if a company wants to attract new investors or skilled directors, it may be necessary to issue additional shares, thereby increasing the share capital.
New shares may be sold or given to existing or new shareholders, to raise additional capital from investors, repay borrowings, fund new projects or reward employees, etc. However, increasing the share capital will generally have the effect of reducing the value of any existing shares, as there will be a higher number of shareholders who will share the proceeds of any dividends.
If more shares are created during company formation (e.g. 10 shares at 10p instead of one share at £1), there will be less need to issue new shares, as the original shares can be distributed to new investors. In this scenario, there will be no need to increase the share capital of the company to attract new investment.
Do I need to increase the share capital to go public?
Once a company has reached a certain size, it may decide to go public (i.e. to convert from a private limited company to a public limited company). Becoming a public limited company (plc) will enable it to list its shares on the London Stock Exchange. This affords the possibility of generating substantial new capital which can be used to expand the business.
“a public company which is incorporated as such may not do business without first obtaining a trading certificate from the registrar. There is a minimum allotted share capital requirement, known as the “authorised minimum”, which is currently set at £50,000 and which must be denominated in sterling.”
As such, it will often be necessary to increase the share capital of a company to obtain a trading certificate and become a plc.
What are the advantages of a large share capital?
Aside from the £50,000 ‘authorised minimum’ share capital requirement to obtain a trading certificate to operate as a plc, there are other occasions where it may be necessary to demonstrate a certain level of share capital. For example, some lenders and creditors might assess the creditworthiness of a company by taking into consideration the size of its share capital. Also, certain trade organisations sometimes apply a membership requirement of a minimum size of share capital.
A larger share capital can have the effect of making a company appear more financially secure. Investors may be more inclined to back a business with more paid up share capital. However, appearances can be deceptive, so increasing a company’s share capital will not necessarily make it a safer bet in the eyes of experienced investors.
Where a larger share capital is being used instead of loans
Some companies will decide to increase their share capital as an alternative to taking out a loan. The advantage of doing so is that there are no interest payments. Although dividends are often paid to shareholders, this depends on the success of the business and there is generally no obligation to pay dividends.
Furthermore, there are no stipulations attached to capital raised from shares; whereas a bank loan can come with various restrictions (e.g. it might only be able to be used for a specified purpose agreed in advance).
Overall, choosing a larger share capital instead of taking out a business loan can offer a company more financial flexibility.
How do I increase the share capital of my company?
To increase the share capital, it will generally be necessary to issue new shares (known as an ordinary allotment of shares). Part 17, Chapter 2 of the Companies Act 2006 deals with the allotment of shares.
The basic procedure consists of passing an ordinary resolution. An ordinary resolution requires a ‘simple majority.’ This means that more than 50% of the votes cast are in favour of the resolution. It requires a vote to be taken as: a general meeting of shareholders; a board meeting of directors; or by written resolution.
Within one month of the allotment of shares, Form SH01 must be filed with Companies House to provide notice of the procedure having taken place. This includes a statement of capital which must be filled out to reflect the company’s issued capital following the changes.
The register of members needs to be updated and new share certificates should be issued within two months.
What are the disadvantages of a large share capital?
If a company starts off with a small share capital, increasing its share capital can lead to the shares of existing shareholders becoming diluted. This can affect both dividend payouts and voting rights.
Although an ordinary resolution is required to allot new shares (i.e. the majority of shareholders will need to approve an increase in share capital) this can leave a minority of shareholders discontent with the change in circumstances, and that can shore up problems for the future.
In general, increasing the share capital through the allotment of new shares will reduce the level of control of the founders (or the original principal shareholders). Although most day to day business decisions can be taken with a 51% stake in the company, the more shares which are created, the more power that is given away.
If there are multiple principal shareholders and a new significant shareholder buys up enough newly created shares, they may be able to form an alliance with an existing principal shareholder, changing the balance of power. At the extreme end, a company which issues too many new shares can become vulnerable to takeover by a competitor.
Even if there is no need to allot new shares, a larger share capital can entail more risk for the existing shareholders. For example, if the nominal value of each share is set at £1,000 compared to £1, each shareholder’s limited liability for the company’s debts would be equal to £1,000 per share owned, as opposed to £1 per share.
Although this may look good to outside investors (i.e. because it demonstrates that shareholders have invested a substantial amount of their own money in the future success of the business), it means that if the company runs into financial difficulty and gets wound up, each shareholder will lose more of their own money.
How can I reduce the share capital of my company?
There are many different reasons for reducing the share capital of a company. But the overall effect will be to transfer capital from the company back to its shareholders. Part 17, Chapter 10 of the Companies Act 2006 covers the reduction of share capital. There are two ways this can be achieved:
- By special resolution supported by a solvency statement of the directors (this route is for private limited companies only).
- By special resolution with confirmation of the court (this route has to be taken by public limited companies).
Within 15 days of passing the resolution, Form SH19 needs to be filed with Companies House, along with: a copy of the shareholders’ special resolution, a directors’ statement of solvency, and a directors’ compliance statement, stating that the solvency statement was made no more than 15 days before the date of the special resolution and was given to the members before the resolution was passed.