Introduction to Alphabet Shares
Alphabet shares, often referred to as "A shares," "B shares," and so forth, are a category of share structure within a company where different classes of shares are labeled with letters from the alphabet.
They’re particularly popular with small businesses and family-run companies due to the flexibility they provide in managing shareholding rights, dividends, and control within a business.
Alphabet shares allow companies to customise shareholding rights among different classes of shareholders, which can be a valuable tool for managing both financial and operational aspects of a business.
Where Did the Name "Alphabet Shares" Come From?
The name "alphabet shares" is derived from the simple practice of assigning different classes of shares with letters of the alphabet. For instance, a company might issue "A" shares, "B" shares, "C" shares, and so forth.
Each of these share classes can carry different rights regarding voting, dividend entitlement, and even access to company assets upon winding up. This labeling convention provides a straightforward way to distinguish between varying types of shares and makes it easier to discuss shareholder rights and obligations.
Why Are Alphabet Shares a Good Option?
Alphabet shares can provide flexibility and are often used for specific purposes by businesses in the UK. Here are some of the key reasons why they may be beneficial:
1. Tailored Dividend Distribution
Alphabet shares allow companies to customise dividend payments to different classes of shareholders. This can be especially useful if a business has shareholders with varying income requirements or tax considerations. For example, one shareholder may want to receive a larger dividend, while another may prefer to leave profits within the business. With alphabet shares, the company can issue dividends selectively to different share classes, helping shareholders optimise their income and tax position.
2. Managing Control and Voting Rights
In companies with multiple shareholders, the ability to assign different voting rights to different share classes can be invaluable. For instance, "A" shares might come with full voting rights, while "B" shares could have limited or no voting rights. This setup allows founders or key shareholders to retain control over company decisions, even if they have minority ownership, while still raising capital or issuing shares to others.
3. Attracting Investment Without Diluting Control
Businesses looking for investment often want to retain decision-making authority. Alphabet shares allow companies to issue non-voting shares to investors, which means they can attract investment without giving up significant control over business operations. This can be particularly advantageous for small businesses and start-ups seeking growth capital while maintaining a clear direction.
4. Income Flexibility for Directors and Key Employees
Alphabet shares can be used to reward key employees or directors in ways that align with company performance. For instance, if the company has a particularly good year, it may choose to issue higher dividends to a specific class of shares held by directors or certain employees. Conversely, during lean years, dividends to these shares can be withheld to conserve cash.
Example Scenario: How Alphabet Shares Work
Imagine a family-owned business with two directors, Alex and Jamie. Alex owns "A" shares, and Jamie holds "B" shares. The company decides to pay a dividend only to "A" shares this year, providing Alex with additional income without distributing profits to Jamie's "B" shares. In the following year, the company can reverse the distribution if Jamie requires a higher income or if the business situation changes. This flexibility is a key reason many small businesses opt for an alphabet share structure.
Alphabet Shares and Articles of Association
While alphabet shares offer various benefits, there’s an important structural consideration to be aware of: the default model articles of association provided by Companies House in the UK do not permit alphabet shares.
Why Are Model Articles Incompatible with Alphabet Shares?
Model articles are a generic set of rules governing the running of a company, provided by Companies House. They’re designed to simplify the setup of new companies and contain standard provisions that make it easy for businesses to get up and running. However, the default model articles are quite limited and don’t provide the flexibility needed for multiple share classes with differing rights. Consequently, they aren’t suitable for implementing an alphabet share structure.
How to Adopt Alphabet Shares Legally
To incorporate alphabet shares, a company must create bespoke articles of association. This customisation allows the company to specify the rights associated with each share class, such as dividend distribution, voting rights, and rights in winding up. Here’s how to do it:
Draft New Articles of Association – Work with an accountant or solicitor to draft articles that explicitly outline the rights associated with each class of shares. This document should be carefully tailored to ensure that each share class serves its intended purpose, whether it’s dividend flexibility, control retention, or investment.
Pass a Special Resolution – Existing companies seeking to adopt alphabet shares will need approval from shareholders. A special resolution (a vote requiring at least 75% approval) must be passed to replace the existing articles with the new, bespoke articles.
File the Articles with Companies House – Once the new articles have been approved, they must be filed with Companies House. Only after this filing will the new share structure, and associated rights, be officially in effect.
Points to Consider When Using Alphabet Shares
While alphabet shares are a popular option, they may not suit every company. Here are a few factors to keep in mind:
Tax Implications – Alphabet shares must be carefully managed to avoid potential tax complications. HMRC may scrutinise dividend payments across share classes to ensure they are in line with the company’s intentions and are not simply a means of avoiding tax.
Minority Shareholder Rights – Alphabet shares can create complexities when it comes to minority shareholder rights. If a class of shares has limited or no voting rights, shareholders may feel excluded from key business decisions, which could lead to disputes.
Legal and Administrative Costs – Implementing alphabet shares requires a bespoke set of articles of association, which comes with legal and administrative costs. This may not be feasible or necessary for very small businesses.
Conclusion
Alphabet shares are a flexible tool that can be valuable for UK companies seeking to manage shareholder rights, dividend distributions, and control. They’re particularly suited to family-run businesses, companies with multiple stakeholders, and businesses seeking investment without diluting control.
However, to make use of alphabet shares, a company must adopt bespoke articles of association, as the default model articles provided by Companies House do not allow for this share structure.
By working with an accountant or legal professional, businesses can draft customised articles of association that enable the use of alphabet shares in a way that aligns with their goals and ensures compliance with UK company law.