Contents
The mechanics of alphabet shares in practice
Structuring your company with alphabet shares
Alphabet shares in family businesses
Alphabet shares for employee incentivisation
Navigating tax implications and legal pitfalls
Best practice for shareholder agreements
Alphabet shares can be a great tax planning tool as you can take dividends independently of each other. Flexibility to split income has traditionally been the preserve of Partnerships or Limited Liability Partnerships but these structures have tax and business risk drawbacks.
When two people work together they can end up with uneven contributions to the business, perhaps because one works full time and the other part time or where one party invested more resources into the venture.
The official tax partnership routes are available but they force you to declare income as you earn it rather than being able to pay tax when you take money out as dividends and leave everything else in there to reinvest or move into holding companies.
Having different classes of share is not only useful in a partnership arrangement but also when you want to incentivise members of your team, but there are restrictions which I’ll cover later.
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Key Takeaways
Alphabet shares allow a company to split dividend distributions and voting rights among shareholders, flexibility and tax efficiency in the company structure.
You must understand and comply with the rules, HMRC and corporate governance when structuring a company with alphabet shares.
Shareholder agreements with alphabet shares must be clear and detailed to avoid disputes and tax and legal pitfalls, anti-avoidance provisions.
Understanding Alphabet Shares: An Overview
Alphabet shares give a company flexibility. When dividends are paid, shareholders get amounts based on the class of share they hold and each class can have different voting rights and dividend preferences. Shareholders can manage their income tax liability and get dividends from their specific share class.
Most companies are incorporated with the standard “Ordinary Share” but there are actually quite a few others. Instead of listing them all, let’s look at the benefits and powers a share can have:
Rights to Dividends
Dividends are a distribution of the company’s profits and are usually paid out pro rata to the shares of the same class, for example, someone holding 60% of a class of share will get 60% of the total dividend declared for that class.
Rights to Proceeds on Sale or Winding Up
Many business owners aspire to sell their business one day and in that event the sale proceeds or profits left in the business after winding up the company are then distributed to the remaining shareholders based on the percentage of shares they hold.
In most cases depending on the percentage of shares held and the duration you can claim entrepreneurs relief on the sale, this 10% is considered generous and allows you to extract up to £1m as a capital receipt.
Voting Rights
Shareholders are sometimes given the opportunity to vote on certain decisions for the company, whether it’s changes at board level or restructuring of shares or sales thereof, having voting power is useful for control of the business.
You can have non voting shares and these are usually the type issued to employees as part of a share incentive scheme. Sometimes shares can also come with limited voting rights attached which puts them in a restricted position but still allows the holders to be part of the company process.
Preference Rights
Some shares have rights to dividends before they are paid to other ordinary shareholders and whilst directors can often issue dividends to specific classes of shares at their discretion, preference rights override that based on the rules attached to the share.
Dividend Waiver
A shareholder may sometimes decide to waive a dividend declared by the company, maybe because they want to avoid higher taxes and leave money in the business for growth while the other shareholders get paid. You can waive a dividend and not take it, but for it to be legal the company must have had the profit reserves to pay it had they not waived it.
Examples of where alphabet shares are useful
Family members often require special rights and privileges in family businesses due to their lifestyle and personal goals, share classes are a useful tool for managing generational wealth.
An alphabet share structure can be particularly useful in a family business as some members getting differential dividends can be more acceptable as long as the family gets more take home pay overall.
Having a new class of share can also give you the opportunity to have the owners of different share classes rank equally when it comes to getting dividends but then have one party prioritised when it comes to the sale of equity in the business.
Disadvantages of alphabet share structure
As an alternative to a limited liability partnership, smaller companies can find an alphabet share structure useful for issuing dividends in a tax efficient way. However a major drawback is that transferring shares can be complicated and requires the statutory forms to be completed and filed.
So when the underlying sale value of a company needs to be redistributed, there can be some issues and in some cases an LLP might be more flexible.
The Mechanics of Alphabet Shares in Practice
The power of alphabet shares lies in their versatility, allowing companies to implement diverse dividend strategies and tailor shareholder rights. But how does this work in practice?
Diverse Dividend Strategies
The power of alphabet shares lies in their ability to have different dividend rates. This flexibility allows for changes in the dividends paid to individual shareholders without having to change the share structure or shareholders agreement. Plus:
Tax efficiency by paying tax efficiently
Fair distribution of shares
Dividends as a tax efficient way of paying directors and shareholders.
Whether it’s Company A or Company B, alphabet shares can be used in any business to assign specific rights and dividend rates to shareholders, so more flexibility and personalisation in the company structure. This results in more efficient and tailored shareholder income.
Tailoring Shareholder Rights
Alphabet shares offer financial benefits but also give companies the ability to customise shareholder rights. For example:
Varying voting rights to different groups of shareholders
Retain control within certain groups
Give certain investors more say in the business whilst managing their dividend income
This is useful for companies that want to retain control within certain groups or give certain investors more say in the business whilst managing their dividend income, as it can pay dividends in the long term.
Indeed alphabet shares can be used to adjust board representation by having different voting and management rights for different classes of shares. This allows certain shareholder groups to have a proportional or designated influence on the board as per the company’s governance policy and the articles of the company.
Companies including joint ventures have customised shareholder rights by using alphabet shares, having frameworks that meet the different needs for voting, dividends and board representation. In this joint venture scenario, Companies House as the official registrar plays a key role in maintaining transparency and accuracy of company information even for companies with only one shareholder.
Structuring Your Company with Alphabet Shares
Now that you know how alphabet shares work, let’s look at how to set up your company with these shares. This means drafting the Articles of Association and complying with the regulatory requirements and record keeping.
Creating the Articles of Association
The Articles of Association is the company’s constitution that sets out the rules for the company and the roles and responsibilities of the directors and shareholders. When it comes to alphabet shares it’s important to include provisions for shareholders to have different classes of shares identified by alphabet letters such as ‘A’, ‘B’, ‘C’ etc.
Amending the Model Articles of Association to include alphabet shares requires a special resolution. This can be done by either amending the existing articles or issuing new ones to include provisions for different classes of shares identified by letters such as A, B, and so on. It’s important to spell out these details in the Articles of Association by:
Creating different classes of shares
Assigning specific rights to each class
Clearly stating the individual rights and dividend rates in the document for each class.
Regulatory Compliance and Record-Keeping
Regulatory compliance is not optional when it comes to alphabet shares. Seeking professional advice is a must to ensure tax compliance. Compliance with HMRC rules and other regulatory requirements is key in setting up Alphabet shares.
Beyond compliance, record keeping is critical. Limited companies have to keep a full record of all issued shares and their respective owners. It’s especially important when dealing with different classes of shares like Alphabet shares which may have different voting and dividend rights. Companies must update these records as soon as new shares are issued.
Alphabet Shares in Family Businesses
Family businesses are in a special situation when it comes to company structures. Alphabet shares in family businesses solves the common problems, allows flexibility in ownership and control within the family business.
Alphabet shares can help family businesses:
Be more tax efficient by customising dividend distributions and tax benefits
Have different classes of shares each with different privileges and dividend rates for different shareholders
Feel a sense of ownership and responsibility in the family business.
Alphabet Shares for Employee Incentivisation
Not just family businesses but other types of companies can also benefit from alphabet shares especially when it comes to employee incentivisation. Alphabet shares can be an effective tool for employee motivation and alignment with business success.
Alphabet shares are more flexible than traditional employee stock option plans because they can be classified into different classes denoted by letters such as ‘A’ ordinary, ‘B’ ordinary, ‘C’ ordinary etc.
This allows companies to offer customised incentives to employees based on the different rights and dividend rates for each class including b ordinary shares. Companies like Google have used Alphabet shares to incentivise their employees, this is a real life example of how this works in business.
Navigating Tax Implications and Legal Pitfalls
Despite the many benefits of alphabet shares they come with complications. Navigating the tax and legal implications of these shares is crucial.
Understanding HMRC’s Perspective
To avoid problems it’s important to understand HMRC’s view on alphabet shares. Dividends from alphabet shares are paid to shareholders based on their shareholding. But HMRC can treat these dividends as employment income in certain circumstances.
Under settlements legislation HMRC says the shares must not have any restrictions such as non-voting or reduced capital rights. And when shares are transferred between spouses they are to be valued at ‘no gain/no loss’ for tax purposes.
Staying Clear of Anti-Avoidance Provisions
Beyond understanding HMRC’s view, being aware of anti-avoidance provisions is also important. These provisions are designed to stop an individual from re-directing their income to get a tax benefit and pay tax.
To avoid these provisions companies must carefully draft their company’s articles, also known as articles of association, to specify the rules and entitlements for each class of shares and ensure these do not conflict with settlement rules.
HMRC anti-avoidance rules in the UK are designed to stop individuals from re-directing their income through alphabet shares by making sure there are no restrictions on these shares such as non-voting or reduced capital rights.
Best Practices for Shareholder Agreements
Now that we have covered the benefits, mechanics and pitfalls of using alphabet shares we can move on to best practices for shareholder agreements. These agreements are key to preventing disputes and getting the most out of the alphabet shares company structure.
When creating shareholder agreements involving Alphabet shares you should consider the following:
- Alphabet share structure
- Issuing new shares
- Protecting shareholder rights
- Key matters in the agreement
To have clear provisions for different rights for Alphabet shares in the shareholder agreement companies should specify the rights that will attach to existing shares and any new shares issued. To prevent disputes companies can include non-compete clauses, clarity on rights, protect interests, offer pre-emption rights to existing shareholders and have transparent terms for share price calculation in case of a Bad Leaver.
Summary
The world of company structures can be complicated but using alphabet shares can be a way to achieve flexibility, tax efficiency and shareholder happiness. By understanding the mechanics, navigating tax implications and best practices in shareholder agreements companies can get the most out of this tool.
Frequently Asked Questions
What is the purpose of alphabet shares?
Alphabet shares for different groups of shareholders to have different rights such as voting rights and dividends.
What is the difference between ordinary shares and alphabet shares?
The main difference between ordinary shares and alphabet shares is that alphabet shares allow companies to divide ordinary shares into different classes by varying the attached particulars.
Do Alphabet shares pay dividends?
Yes they can depending on the rights of the shares.
How are alphabet shares typically designated?
Alphabet shares are usually designated as ‘A’ shares, ‘B’ shares, ‘C’ shares and so on each with its own set of rights and benefits.
