When you are looking to become incorporated, it's important to follow all of the mandatory stages that are required of limited companies. Amongst the various taxes, insurance and other legal requirements, you will also need to know what share capital is and why it is important for your business.
You will probably have come across the concept of shareholders, but you may not know why they are important in terms of the running of your company.
In this guide, we'll talk you through what share capital is used for, what it means for your company and the different types of share capital that you may come across. Let's dive in!
When companies form, they issue shares to each of their shareholders. The total value that the shares are sold for is combined to make the 'share capital' (also known as equity capital). Every limited company must issue at least one share when it is set up, but there is no limit on the maximum number of shares that can be given out. Usually, 100 shares are sold for £1.00 when a company is first formed, which means that they are easy to keep track of as each share equals one per cent.
The worth of the company's share capital is different to the market value of the shares. This means that the shares could sell for more than they were initially bought for. The additional paid-in capital is the variant between what investors pay for the share and the par value of it.
Continue reading to find out more about share capital and why it is important to the running of your company.
What are shareholders?
A shareholder is a person or legal entity that has ownership over at least one share in the company. They own a certain percentage of the company based on the number of shares that they have, which means two shareholders with 50% of shares each have equal ownership. The number of shares can impact the voting rights of shareholders because they are allowed more say if they own a larger chunk of the company's shares.
Shareholders earn money when the company does, as they have partial ownership over it. As limited companies are separate from the financial responsibility of the directors and shareholders, they have full financial liability and ownership over their shares of the company. They may also receive a portion of the money should the company and its assets become liquidated.
Shareholders' equity shows the distribution of the shares, as well as any company debts or other liabilities that they may have. The company can pay dividends to the shareholders, as this is when some of the company's earnings are distributed, although additional stock shares can also be given in payment.
Shareholders have a multitude of responsibilities within the company, alongside getting paid some of the profits. They are required to help decide on the powers that the company directors have, as well as the responsibility of hiring new directors or removing them from their posts. The directors' salaries are also decided upon by the shareholders, as well as making other decisions that the director can't be involved with.
Perhaps most importantly, shareholders are also responsible for looking over the financial statements of the company and making sure that they are correct and whether they need to make any changes to the running of the company in the future.
What is share capital used for?
There are many advantages to using share capital within a limited company. They show the business' distribution of ownership and therefore can help influence who makes the company decisions. The financing of the company can also be paid in capital rather than loans, which eases the threat of debt. The overall worth of the company will be compiled on a financial document called a balance sheet, which will show the distribution of shares.
Shareholders and directors are also not personally responsible for the finances of a limited company if anything were to go wrong. In addition, the company is taxed separately to the shareholders.
There is no obligation to pay shareholders dividends if the company suffers from a poor financial year. This means that a business can recuperate without worrying about paying out large sums of money. Share capital is also a constant source of permanent capital, which means that shareholders cannot be given a refund on the shares that they have invested in. The shareholders must instead sell the shares if they no longer want their shares.
Companies can use the sale of shares to raise money for whatever they choose. There are no restrictions connected to the funds raised by share sales, unlike funds that are provided by a creditor, which may have stipulations attached to how the money is spent.
The process of raising equity through share capital can be a flexible process as the company has complete control over how shares are distributed, including the price they are sold for and when the shares go on sale.
Unlike creditors, shareholders also can't force a company into bankruptcy if it hasn't made the payments. Creditors, on the other hand, can do this if a company fails to pay the interest that it owes.
Types of share capital
There are various types of share capital due to the requirements of individual companies. Below is a list of the different types and what they can mean for your business. Throughout the various classes of shares, they are kept at a fixed value. This is called the nominal value.
Below is a list of the different types of share capital:
Ordinary shares
As the name suggests, ordinary shares are the most common type of share. These kinds of shares mean that there is one vote per share so that all of the shareholders have equal voting rights.
Non-voting shares
Unlike ordinary shares, non-voting shares don't allow shareholders to participate in important votes about the running of the company. They tend to be given to employees as they can be paid as dividends.
Preference shares
Companies pay dividends to shareholders with preference shares before those with other types of shares. Usually, these shares don't accompany voting rights, but dividends aren't usually restricted and are paid around three to six months. The preferred stock and dividends are paid out to shareholders before it is to those with common stock and dividends.
Redeemable shares
Companies are able to buy redeemable shares back after they have been distributed. This could be at a fixed time due to a specific event or at the director's discretion.
What are the disadvantages of share capital?
The distribution of shares means that companies have less say over business deals and management of the company because each shareholder has the right to vote on such matters. This means that the running of a company can completely change if the shareholders decide that they don't like the current management and want to have a change around in the management team.
Shareholders also expect a higher return rate for their shares as they are at high risk if the company goes bankrupt. Companies will usually lose more stock at a lower price as compensation for this increased risk level.
Companies must also keep their shareholders up to date with the performance and finances of the business. This means that information that would otherwise be kept private within the company is now out in the public domain. As a result, the company may come under more scrutiny than it would if it only had creditors invested in the business.
The founders of a company lose more control each time they give away shares to the business. In some extreme circumstances, the company may be vulnerable to a takeover if a large chunk of shares have been given away and the power lies with shareholders rather than the business' founders.
Summary
Share capital is the overall value of the shares that are owned by the shareholders of a company. Every limited company must have distributed at least one share, but there is no limit on the number of shares that are issued by the business. Limited companies can have as little as one shareholder in the company, which is often the sole director.
There are various types of shares, including non-voting, redeemable and preference shares. These are given out based on whether the shareholder is going to be given a say in company matters and whether the company will eventually want to buy back the shares.
A share capital shows the distribution of who owns the company and the voting rights of the company's shareholders. Selling shares can be used to raise finances for the company, as the shareholders are invested in improving the companies profits because they have a stake in the earnings and dividends.