Alphabet shares are common in owner-managed businesses (OMBs) and small and medium enterprises (SMEs). They are beneficial to the initial shareholders for a variety of reasons, including preserving control, tax planning and allowing flexibility in the day to day management of a company.
Share classes
Shares can be split into classes. The most common classes of shares are ‘ordinary’, ‘preference’ and ‘redeemable’ shares. Each of these classes may then be split into individual sub-classes. For example, ordinary shares which may be split into further sub-classes often referred to as alphabet shares.
Class rights
The rights that may attach to shares are varied. The three core rights that attach to all ordinary shares usually relate to dividends, voting and a right to capital upon a sale or winding up of a company. Shares rank equally in relation to all three, unless stated otherwise. Class rights are usually contained in the company’s articles of association or contained in shareholders agreements. Share classes are usually utilised when one or all of the core rights are amended in a certain way so that they do not rank equally and these amendments can be advantageous for OMBs and SMEs.
Alphabet shares
Alphabet shares are the most common example of different share classes seen in SMES, named for the letters used to differentiate each class i.e A Shares, B Shares, C Shares etc. The benefit is that each class can be given different rights, for example weighted voting rights or preferential dividend payments.
An example of class rights for alphabet shares is the payment of different dividends. If four shareholders each held one ordinary share in a company they would each have an equal right to a dividend, so 25% of any declared dividend. If the board decided to issue different dividends to each shareholder, for example 40%, 30%, 20% and 10%, it could not do so without the consent of each shareholder. Obtaining consent is unlikely to be practical and shareholders may not be willing to give it.
Alphabet shares can get round this by creating weighted dividend rights. In this scenario each shareholder would still hold one ordinary share, but each with a different class (A, B, C and D). The benefit of this is that dividends can be differential, meaning that they are at the discretion of the board (it may also be decided to fix the dividends for a class in certain circumstances). Weighting in this way can be used to reflect the level of input some shareholders have in the business over others, or sometimes to reflect any initial working capital provided by certain shareholders to the company, meaning that they are repaid before any other shareholders receive a dividend.
The payment of different dividends to each shareholder can also be used in a tax planning scenario, for example a husband and wife who fall into different tax brackets. A smaller dividend is paid to the spouse who is an additional rate taxpayer, whilst a larger dividend can be paid to the spouse who may be a lower rate taxpayer.
For more detail regarding the benefits of share classes and alphabet shares contact our corporate solicitors to discuss.