What are alphabet shares?
While many companies manage well with only one class of share – ordinary shares – others find it advantageous to create different classes of shares, allocating different rights to each class – so called ‘A’, ‘B’, ‘C’ or ‘alphabet shares’.
The rights of each class of shares will be set out in the Shareholder Agreement. Any class of share, regardless of its label, can be bestowed with the key rights. Or all shares could all be created equal. It is up to the shareholders to decide at the outset.
The lettering system doesn’t in itself create a hierarchy of rights. This is not a measure of celebrity status. A shares are not automatically more glamorous than B shares. D shares could be just as desirable as C shares. There is no need to take offence or feel shame if you are being offered Z shares. The shares could even be distinguished by colour code: red shares, yellow shares, blue shares. Labels are just labels.
Different classes of shares are commonly used to create a means of allocating dividends to shareholders in a more tax efficient way, allowing different rates of dividends to be paid to different classes of shareholder.
What are share class rights?
Different classes of shares can also carry different rights, such as the right to vote at shareholder meetings, the right to receive dividends, or the right to receive a share of the sale proceeds when the company is sold. Creating different share classes can also be used for a founding shareholder to retain greater control over the company – he may create non-voting ‘B’ shares for the other shareholders which only enjoy dividend rights, while retaining all ‘A’ shares, which could be bestowed with the voting rights, for himself.
Mark Zuckerberg exercises almost total control over Facebook, whilst owning approximately only 25% of its shares.
Where shares are offered as an employee incentive the availability of different classes of shares can be a particular boon, granting an employee the right to receive a small share of the sale proceeds if the company is sold in future, without inviting them to have a say in board meetings or even paying them annual dividends.
Once created, it is fair to the shareholders to spell out that the share classes cannot be changed without the consent of those holding the relevant class of shares (for example, by converting full voting ‘A’ shares into non-voting ‘B’ shares). The Shareholder Agreement can provide a detailed summary of each share class, to avoid confusion.
Do the directors have authority to issue new shares?
Now, this one is tricky, with several provisions under the Companies Act 2006 to consider.
Firstly, the directors need authority under the Articles of Association to allot shares.
Secondly, the existing shareholders may need to waive their right of first refusal over any new shares (known as waiver of pre-emption rights).
The Shareholder Agreement should be used to clarify each of these areas, stating whether the directors have full authority to issue new shares and, if not, what percentage of shareholders need to back the director’s decision to allow new shares to be issued.
Have you checked the Articles of Association?
A company’s Articles of Association is like the founding constitution of a company. But that is where the comparison with a constitution ends. A real constitution, for example, the Constitution of the United States of America, is tailored to suit the citizens that it governs. However, in 99 per cent of companies the Articles of Association is a one-size-fits-all document that is not even read before it is adopted and registered at Companies House. It’s rather like Scotland declaring independence from the UK and deciding to adopt the American Constitution as their own, lock, stock and barrel.
A Shareholder Agreement addresses this mismatch by putting in place a set of rules that are tailored to suit the way you do things in your own company and which take priority over your Articles of Association.
Before putting in place a Shareholder Agreement it is advisable to review the existing Articles of Association and, in some cases, to make amendments to get rid of any obvious conflicts between the rules set out in the Articles of Association and the rules in the Shareholder Agreement.