The pros and cons of share capital

Hi there, Nicholas Campion here from 1st Formations, and welcome to another episode of Whiteboard Thursday, where we provide advice on a wide range of business and company matters.

If you find this video useful and you enjoy it, please give us a like and share it with your friends and colleagues.

But for now, let’s get started. Today, I want to discuss the pros and cons of share capital.

The size and shape 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.

But first, for those new to company matters, let’s consider what we mean by share capital.

Ok, a limited company must assign a ‘nominal’ value to each of its shares upon incorporation, for example – £1.00. This nominal value, also known as the par value, represents the limited liability of the company’s 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. You will sometimes see this referred to as the aggregate nominal capital. So, for example, if a company has 100 shares at a nominal value of £1.00 each, 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.’

In the context of this video and what we are talking about today – we are discussing the merits of living with a large share capital either from the point of incorporation or later by choosing to utilise share capital as a means to develop a business rather than using other vehicles such as business loans and so forth.

Without further ado let’s dive into the heart of the issue – the pros and cons of share capital – starting with the pros.

There are 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 a large 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.

Some companies will decide to increase their share capital as an alternative to taking out a loan. The advantage being – 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. For example, it might only be able to be used for a specified purpose agreed in advance.

Overall, using share capital instead of taking out a business loan can offer a company more financial flexibility.

Now let’s consider the disadvantages of share capital

Increasing a company’s share capital can lead to the shares of existing shareholders becoming diluted. This can affect both dividend pay-outs and voting rights.

Although an ordinary resolution is required to allot new shares, that is – 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 create problems for the future.

In general terms, increasing the share capital through the allotment of new shares will reduce the level of control of the founders, as the more shares that are created, usually means 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 that 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 create 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.

This may look good to outside investors because it demonstrates that shareholders have invested a substantial amount of their own money in the future success of the business. However, if the company runs into financial difficulty and gets wound up, each shareholder will lose more of their own money.

Now that we have walked through the pros and cons of share capital – just how do you increase or decrease it?

First of all, let’s take a look at how a company can increase its share capital.

It will generally be necessary to issue new shares, known as an ordinary allotment of shares.

The basic procedure would normally require the existing shareholders to pass a special resolution consenting to the issuance and waving their right to pre-emption on the new shares. This requires a majority of 75% or more of the votes cast in favour of the resolution at a general meeting of shareholders, or by written resolution.

The company and its directors are then usually allowed to issue the shares; however, these procedures may differ from company to company.

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 form includes a statement of capital which must be filled out to reflect the company’s issued capital following the allotment.

Finally, the register of members needs to be updated and new share certificates should be issued within two months.

Now let’s look at how to reduce share capital.

There are many different reasons for decreasing the share capital of a company. But the overall effect will be to transfer capital from the company back to its shareholders. It is worth remembering there are strict rules on this matter and if you are unsure of them, you should seek professional advice.

In general terms, a reduction in share capital is usually achieved with a special resolution supported by a solvency statement of the directors.

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’ statement

And remember, a reduction of capital carried out in this way is only effective when Companies House process the SH19 Form.

And there you have it. Today, we have provided an introduction to share capital, the pros and cons of share capital, as well as using it as a means of developing your business, and also the procedures of how to increase and decrease it.

If you have any questions, please leave them in the comments section below, and in the meantime, be sure to subscribe to our channel to get more advice on limited companies, reporting requirements, and tax obligations.

We’re always happy to hear from you, and we cannot wait to help. Until next time, cheerio.