Share capital represents the total value of shares sold by a limited company. The extent to which and how private limited companies use share capital as a method of raising money depends on their business strategy, funding requirements, and willingness to relinquish full ownership, among many other factors.
In this article, we will discuss the advantages and disadvantages of using share capital to raise funds for your private limited company.
Share capital is the nominal value of all of the shares issued to shareholders (members) of a limited company; in other words, it is the amount of money raised by selling shares. Share capital is one of the primary ways by which private limited companies generate money to fund their growth. Share capital is often used as an alternative to borrowing money, also referred to as debt capital or debt financing.
Limited companies are required to set an initial nominal value for each share at the time of their incorporation. Hence if 100 shares are issued at a nominal value of £1 each, the total nominal value is £100. The nominal value represents the “face value” of the shares issued and is the minimum amount that must be paid for each. A company’s value is defined by its current market value rather than its nominal value, however.
As part of the company registration process, you will be asked to provide certain information on your initial share capital to Companies House, including the number of shares, the total value of the shares, and the names and addresses of shareholders.
Shareholders, also referred to as “members”, are individuals, organisations or other legal entities with a shareholding (i.e. one or more shares) in a limited company. Put another way; shareholders are the ultimate owners of a limited company. In return for their ownership of shares, shareholders gain certain rights, including the right to vote on company matters (e.g. whether a new director should be appointed), receive company reports, exchange their shares for money, and receive dividend payments. It is possible for one person to be a sole director and shareholder in a business. A shareholder with less than 50% of all shares is considered a minority shareholder. A shareholder with more than 50% of all shares issued is a majority shareholder.
Shareholders should not be confused with stakeholders who have an interest in a company but may not necessarily hold shares.
As with all decisions relating to the running of a limited company, it is important to weigh up all options available to facilitate the raising of funds and the relative advantages and disadvantages of each.
There are several distinct reasons to consider using share capital to raise funds for a private limited company, as follows:
No need to make regular repayments
Unlike the use of debt to raise capital, such as bank loans or bonds, share capital removes the need to make regular loan repayments. While there may be no requirement to make loan and interest payments, limited companies should consider whether they will need to pay dividends to shareholders.
Established greater levels of creditworthiness
Many lenders and creditors will ask to see evidence of a minimum level of share capital as part of the process of ensuring the creditworthiness of those they lend to. Share capital is beneficial because it provides reassurance to lenders, creditors, customers, and investors that a limited company is financially secure. It should be noted, however, that whilst robust levels of share capital may offer reassurance for those who wish to invest, seasoned investors will look at a wider range of factors before deciding where to place their money.
High levels of financial flexibility
Holding share capital provides limited companies with a great of flexibility and discretion when it comes to deciding how to best use funds. This may not be the case for debt if creditors stipulate certain restrictions on how the money can be used. Companies also have discretion over how many shares they issue and the nominal value for each. This allows limited companies to raise more money in the future if they are in a position to do so. In addition, by raising money through share capital, a limited company can exercise discretion over the type of shares, the rights of shareholders, and its rights to buy back shares in the future.
Lower risk of bankruptcy
Share capital provides greater levels of confidence that a limited company has a lower risk of running out of capital and hence becoming bankrupt. Whereas creditors, such as banks and suppliers, can actively seek to make a company bankrupt that is not repaying its debts, this is not the case for shareholders. On the contrary, those with an investment in the shares of a limited company have a vested interest in its overall success and can play a personal role in achieving this.
Diminished control and ownership
Each share that is issued and sold represents part of a business for which control and ownership are relinquished by the founders. This means that limited companies lose some of their right to steer the direction of the business and make important decisions on its future. This is especially so if shareholders own more than 50% of all company shares, as they can make changes to the senior management structure if they are unhappy with how things are being run. In some cases, this can even lead to a hostile takeover of the company by an alliance that wishes to see change.
While it is advantageous to have the option to raise additional share capital in the future by issuing new shares, this may come at a cost to existing shareholders whose holding will be diluted. Existing shareholders may also see their dividend payments and voting rights reduced.
More public disclosure of company financial information
Companies raising funds through share capital are required to disclose additional financial information to Companies House that is then placed into the public domain.
Lack of tax deductibility
Whereas any interest paid on debt owed by a company to a lender can be used to reduce its tax bill, this is not the case for dividends or where capital is used to buy back shares.
To raise more share capital, limited companies have to gain approval from shareholders in the form of an ordinary resolution. This means that the majority of shareholders must back the changes being put forward. For the reasons of share dilution outlined above, shareholders who do not approve of the increase in share capital may be left feeling marginalised.
If the nominal value of shares in a limited company increases in the future, this means that each shareholder’s limited liability increases correspondingly. As such, this may pose a significant risk for shareholders if the company runs out of money and is forced to wind up. In this scenario, each shareholder will lose more of their funds.
Cost of preparing an initial public offering (IPO)
If a limited company decides to organise an IPO, this can be extremely costly in terms of preparing a prospectus, legal fees, accounting fees, listing fees, advertising, and underwriting fees (the single biggest cost).
Over time, limited companies may wish to raise or lower their levels of share capital. The raising of share capital is normally undertaken by issuing new ordinary shares. To do so, company members must waive their right of pre-emption on the issuing of new shares by way of a special resolution approved and signed by at least 75% of shareholders. The new shares can then be issued, and notification (using form SH01) must be given of the change to Companies House within one month. The register of members must also be updated, and share certificates issued to new shareholders.
Share capital can also be reduced by passing a special resolution and the directors must also draft a statement of solvency. Once the special resolution is passed, form SH19 must be completed and submitted to Companies House with the resolution, the statement of solvency, and a director’s statement to inform them of the change.
Selling shares to generate share capital is a widely used and highly advantageous method of raising funds for private limited companies. It is important to understand the pros and cons of using shared capital, not just initially but over the life of the limited company. If you are considering share capital, an initial public offering (IPO), raising or lowering your share capital, or making any decisions regarding your company’s share capital, it is important to seek expert advice before you do so.
Uniwide Formations is a leading company registration specialist based in Central London. Our team of knowledgeable and highly experienced company formation experts can handle all aspects of your limited company or LLP registration. We will also ensure that the details of your company’s share capital arrangements are filed with Companies House in accordance with the law.