When a company has multiple shareholders, there’s often a need for a tailored ownership structure that allows for different rights and privileges between shareholders. Alphabet shares can offer a solution. This flexible yet relatively simple share class enables a company to provide different dividend, voting, and capital rights to different shareholders.
This post explains the basics of alphabet shares, the most common reasons for issuing them, and the procedures you must follow to create alphabet shares during or after the company formation process.
Key Takeaways
- Alphabet shares are ordinary shares structured into different classes, such as ‘A’ shares, ‘B’ shares, and ‘C’ shares.
- Companies issue alphabet shares to vary the rights and privileges of different shareholders.
- When issuing alphabet shares to family members, companies must be mindful of HMRC’s anti-avoidance settlements legislation.
What are alphabet shares?
Alphabet shares are a type of ordinary share that limited companies can issue to shareholders (also called the ‘members’). They are structured as different classes of ordinary shares and are usually named ‘A’ ordinary, ‘B’ ordinary, ‘C’ ordinary shares, and so on (this is where the term ‘alphabet shares’ comes from).
Ordinary shares typically provide basic shareholder rights, namely:
- Full rights to attend and vote at a general meeting of the company’s shareholders (one vote per share)
- Right to receive equal dividends per share (dividends are distributions of company profits)
- Right to share in any distributions of surplus capital, including on the winding up of the company
Most companies only issue ordinary shares, so these basic rights are normally pro-rata based on the number of shares each member holds. For example, a shareholder with 25% of a company’s ordinary shares would have the right to 25% of dividends, voting rights, and capital on the winding up of the company.
With alphabet shares, companies can assign different levels of these rights to each class, resulting in some rights applying to one class of alphabet shares but not another. For example:
- A ordinary shares – full voting rights, full dividend rights, full capital rights
- B ordinary shares – no voting rights, full dividend rights, no capital rights
- C ordinary shares – full voting rights, no dividend rights, full capital rights
Alphabet shares can also provide varying rights, such as variable dividend rates, enhanced voting rights, or different rights to capital on winding up.
Why would a company issue them?
There are various reasons why companies issue alphabet shares. Often, they relate to the degree of each shareholder’s involvement in the business, the risk they take, or the extent to which founding or controlling members wish to provide voting privileges to other shareholders.
Tax efficiency is often the main motivator. For example, with alphabet shares, a shareholder could own 10% of issued shares that provide entitlement to 50% of any dividends. If there was only a single class of ordinary shares, the shareholder would only be entitled to 10% of any declared dividends.
This strategy can be beneficial where some shareholders are basic-rate taxpayers while others are subject to higher or additional tax rates. However, you’ll need to be mindful of HMRC’s ‘settlements’ legislation in this situation (we will discuss this later in the post).
Other common reasons for creating alphabet shares include:
1. Varying shareholder rights in a family-owned company
It’s common in family companies to distribute shares to various family members, particularly spouses and children. The purpose may be to reflect their different levels of involvement, utilise everyone’s tax-free allowances, create passive income for loved ones, or build generational wealth.
2. Awarding shares to employees
Issuing shares to employees can be a great way to incentivise workers and foster loyalty. When using alphabet shares as part of an employee share scheme, companies will typically structure them as having the right to receive dividends, but no rights to vote on any decisions or receive any capital rights.
3. Ensuring majority voting rights remain with the founders
Founding shareholders or key investors may wish to retain majority decision-making powers while continuing to raise capital and issue dividends to other shareholders. Alphabet shares can be structured to facilitate this.
4. Facilitating joint ventures
When two or more companies wish to set up a separate joint venture company, alphabet shares can make it easier to define each party’s varied ownership rights and level of control in the new company.
Mistakes to avoid
One of the most common mistakes companies make when issuing alphabet shares is failing to update the articles of association to create the new share classes and specify the attached rights. The rights attached to shares are known as the ‘prescribed particulars’. Unless specified otherwise, all company shares will normally rank equally (pro rata) and provide the same voting, dividend, and capital rights per share.
This oversight can potentially result in the payment of illegal dividends, which can have serious consequences for the company and its directors. It could also lead to shareholder disputes, difficulties when seeking new investors, and potential issues during any future sale of the company.
Beware of HMRC’s ‘settlements’ legislation
Under anti-avoidance settlements legislation, HMRC may challenge certain dividend arrangements on the basis that an individual shareholder gains a tax advantage by diverting some of their dividend income to another person who is liable to a lower tax rate (or not subject to tax).
This legislation is a key consideration when issuing alphabet shares, particularly when gifting shares and distributing dividends to spouses, civil partners, and minor children in a family company.
If HMRC suspects that settlements legislation applies, the diverted dividend income may be deemed to belong to the settlor rather than the recipient shareholder for tax purposes.
Companies should seek professional advice and guidance before creating and issuing alphabet shares to avoid such issues.
How to issue alphabet shares
Issuing multiple share classes, including alphabet shares, is always more straightforward during the company formation. However, it’s also possible to create new share classes after incorporation to reflect the evolving needs of a company and its shareholders. We outline both options below:
Option 1: Creating alphabet shares on incorporation
Generally, you should not use the model articles of association to set up a company with multiple share classes. Therefore, to issue alphabet shares during the company formation process, you must add specialist provisions to the model articles of association or create entirely bespoke articles.
These provisions outline each share class and the rights attached to them. You’ll then summarise the prescribed particulars of each share class on the incorporation application (form IN01).
As part of the incorporation process, you’ll also need to provide details of the individuals or entities holding the initial shares of each share class. These individuals are the subscribers – the founding shareholders of the company.
At Quality Company Formations, we provide a specialist Multiple Share Class Package for customers wishing to set up a company with more than one class of shares. Our Company Secretarial Team can provide a Drafting Service if you need help creating bespoke articles.
Option 2: Creating alphabet shares after incorporation
To create alphabet shares for an existing company, the shareholders must pass a special resolution to amend the company’s articles. The amended articles should specify the alphabet shares and the rights attached to them.
Next, the shareholders usually need to pass an ordinary resolution authorising the directors to issue the alphabet shares, per Section 551 of the Companies Act 2006. This authorisation specifies the number of shares the directors can issue and the permitted timeframe for doing so (maximum period of 5 years).
Within 15 days of these changes, the directors must send a copy of the resolutions and the new articles as amended to Companies House with the relevant statutory form. Thereafter, the directors can issue alphabet shares to the relevant shareholders by following the usual issue of shares procedure. This normally involves:
- Passing a board resolution to approve the issuance
- Where applicable, passing a members’ resolution to disapply any pre-emption rights or otherwise deal with other restrictions that may be in place
- Completing a return of allotment of shares (form SH01) for Companies House and filing it within 1 month, along with the members’ resolution (if applicable)
- Providing share certificates to the relevant shareholders
- Updating the company’s register of members (and the register of people with significant control, if applicable)
- Updating details of shares and shareholders on the next confirmation statement
If pre-emption rights apply, the company may first have to offer the new alphabet shares to existing shareholders. However, there are exceptions to statutory pre-emption rights, including the allotment of shares to employees.
The process of issuing new shares can be complex. To ensure any new share structure complies with relevant legislation and aligns with your company’s goals, you should seek advice from an accountant or legal professional.
Updating the articles of association after issuing alphabet shares
A company must update its articles of association accordingly when issuing any share classes other than ordinary, including alphabet shares. The shareholders must pass a special resolution at a general meeting or in writing to do so. This type of resolution requires a 75% majority vote in favour of the change.
If a shareholder’s agreement is in place, it should be updated at the same time. When making any such changes, you should ensure there are no discrepancies between the articles and the agreement.
Amending these documents is relatively straightforward, but we recommend consulting a commercial solicitor to ensure the correct procedures are followed and that any changes are appropriate, enforceable, and comply with company law.
Do I need a shareholders’ agreement?
A shareholders’ agreement is an optional, private contract between the members of a company limited by shares. However, creating a properly drafted agreement is advisable if your company has more than one shareholder and issues multiple share classes.
Thanks for reading
Whether you’re considering giving shares to loved ones, setting up an employee share scheme, or entering a joint venture with other companies, alphabet shares are the ideal share class for varying shareholder rights.
If you have questions or need help setting up a company with alphabet shares, please comment below or contact our company formation team. If your situation is particularly complex, you may also wish to speak to your accountant or a commercial solicitor.
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Please note that the information provided in this article is for general informational purposes only and does not constitute legal, tax, or professional advice. While our aim is that the content is accurate and up to date, it should not be relied upon as a substitute for tailored advice from qualified professionals. We strongly recommend that you seek independent legal and tax advice specific to your circumstances before acting on any information contained in this article. We accept no responsibility or liability for any loss or damage that may result from your reliance on the information provided in this article. Use of the information contained in this article is entirely at your own risk.
Excellent article! I will implement this alphabet shares knowledge in my own tax planning UK business.
Thanks a lot for your positive comment, David.
We’re so pleased you enjoyed our recent blog.
Kind regards,
The QCF Team.