Company Law – Capitalisation
Share capitalisation (or “capitalization”) refers to the capital structure of a corporation, in other words, the nature of a company´s wealth – including how many shares a company has and how those shares are structured. The terms “equity securities” or “equity” also refer to the shares of a corporation. A share (US: stock) is a fractional part of the capital of a corporation which becomes a person’s personal property when bought. However, the corporation’s assets remain the property of the corporation. Shares confer both rights and liabilities onto the owner. Possible rights may include the right to dividends, the right to vote and/or the right to participate in the distribution of assets upon the winding up of the company. Shareholder liabilities may include the responsibility to contribute to the capital of the company. The rights and obligations of a particular class of share are normally described either in the articles of association (US: by-laws) or in a shareholder agreement (Appendix 1 contains a sample shareholders agreement).
Share capital is divided into “authorised capital” (US: “authorized capital” or “nominal capital”) and “issued capital”. Authorised capital is the maximum amount of shares a corporation is authorised to issue. This authorisation derives from one of the company’s constitutional documents. A portion of the authorised capital can (and often does) remain unissued to shareholders. Those shares that are actually issued to shareholders are referred to as the “issued capital”. When a share is issued to a shareholder, a certificate is normally distributed evidencing that the listed person is a registered shareholder. That person’s name also enters the company’s share registry.
Different classes of shares
A company may have different classes of shares which confer different rights upon their owners. Each class contains different rights with respect to voting, receiving dividends and receiving capital in the event of a winding up. Different jurisdictions may allow a variety of classes of shares to be issued, but there are some common classes:
This is the most commonly held type of share in a company. Ordinary (US: common shares) are the most familiar form of stock ownership, with the investor making or losing money depending on company (and thus, share) performance. In general, however, ordinary carry the most risk since holders of preference shares will normally recover their contributions first following the winding up of a company.
This is the class of shares which carry additional rights above and beyond those carried by ordinary shares. Usually this includes a right to a dividend, if declared or resolved by the board of directors. Preference may also be given upon the winding up of the company. However, preference shares (US: preferred shares) usually do not carry voting rights. Different classes of preference shares may also be issued by the company (e.g., some are called “Class A Preference Shares”, “Class B Preference Shares”, etc.). Preference shares are more common in private companies.
Sometimes certain rights will be granted to certain shareholders; this would often be agreed upon in the shareholders agreement. One right that may be available to a shareholder is the right to convert shares into shares of another class (“convertible shares”). Shareholders may sometimes have a “pre-emption right” (US: pre-emptive right) or a “right of first refusal” which protects the shareholder’s existing holdings. It consists of the right to an option to take up a “pro rata” (proportional) portion of any new issue of shares. These are just two examples of the many kinds of rights and options that may be offered to shareholders in a shareholders agreement.
The concept of a “dividend” has been mentioned several times so far. When a company earns a profit, this profit may be reinvested in the company or it may be distributed to shareholders in the form of a dividend. Different jurisdictions will determine how often a dividend will be distributed. In the US, dividends are often declared quarterly. Sometimes the board of directors will propose a dividend and the shareholders must vote on it. The most common form of dividend is a cash payment. Dividends may also be distributed in the form of additional shares or in property (which is extremely rare).
Law in Practice
Corporate lawyers advise on matters relating to share capitalisation. This may involve providing advice and drafting documents relating to the issue of shares to existing shareholders (known as a “rights issue”) or to a particular group of investors (known as a “private placement” or “placing”). The company may wish instead to raise capital by offering shares to the general public, by way of an IPO (“introductory public offer” or “initial public offering”). Following the IPO, the company would then usually be listed on a stock exchange. An offer document must be drafted and a number of regulations need to be complied with, so a lawyer’s advice is essential.
US Securities and Exchange Commission (SEC)
UK Financial Services Authority (FSA)
Appendix 1: Sample Shareholders Agreement
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