As part of an investment or re-structuring, many companies will want to reorganise their share capital and end up with classes of shares of greater or lesser denominations. The “original” shares may then need to be removed from the equation, and unfortunately shares cannot just vanish into thin air.
There are various ways to deal with these original shares to make sure they do not affect the intended equity position after the restructuring or investment. Listed below are the most likely solutions:
Gifting
The shares could be gifted back to the company without payment (in legal speak, for no consideration). As a gift, the shares will not fall within the formalities required for a company to buy back its own shares. A stock transfer form is necessary to transfer legal title, but as there is no consideration there is no stamp duty payable.
Although the Companies Act 2006 does not specifically confirm the details, it seems that any gifted shares continue to exist with the company noted on the register of members as the holder of those shares.
If the company wanted to then cancel the gifted shares it would need to follow the steps to reduce its capital. Provided the articles of association give the company the power to do so (and post Companies Act 2006 this is the default position, meaning that unless the articles expressly prohibit the reduction of capital it is permitted). The two necessary steps are then: (i) the signing of a statement of solvency by all directors (ii) the approval of the shareholders by special resolution. If the company reduces its share capital, a form SH19 must be filed at Companies House.
Re-classify
The shares can be re-classified as a different class of shares (e.g. B shares) and those shares can then be given no dividend or voting rights, greatly reducing the value of those shares. To achieve this, a special resolution varying class rights will be required and form SH02 (varying share rights) and form SH08 (re-designating shares) will need to be filed at Companies House.
Buy Back
If there are sufficient profits, the company can buy back shares under the company buy back procedure. Essentially, provided that the company articles do not restrict or prohibit buy backs, the company can make an off-market purchase of its own shares with the authority of the shareholders. The contract for the buy-back of shares must be approved by an ordinary resolution of the shareholders.
Although this is a broad enough subject to deserve its own blog, if there are not sufficient distributable profits, there are also circumstances where the buy back can be financed from proceeds of the issue of new shares, with cash up to the lower of £15,000 and 5% of share capital or even out of capital, provided that the directors are able to give a director’s statement in the prescribed form, and a notice is published in the Gazette, putting the world at large on notice of such proposed buy back. There are certain tax and procedural complications to this approach, but if no other approach will work it is worth considering this http://www.gannons.co.uk/expertise/case-studies/tax-law-case-studies/tax-on-share-buy-back/.
2013 Buyback regulations
Since 30th April 2013 all private companies have had a useful new provision available to them – to buy back shares of the company held by employees out of cash even if the company does not have distributable reserves to cover that amount.
If a company wishes to do this it must have authorisation from its articles. Therefore the first step is to check the company’s articles to make sure that the company is not prohibited from buying back its shares. A company is free to buy back its own shares unless the articles expressly limit or prohibit the buying back of shares.
If there is such a restriction, unless the restriction is entrenched (meaning an article whose intent is to prevent subsequent amendments), the articles can be amended by special resolution (needing 75% of the shareholder votes).
It does not seem that a company can provide for share premium in using this provision, so shares can be bought only for nominal value.
However, given that this is such a useful procedure, especially for the buy-back of employee shares, it is well worth checking the company’s shareholder agreement to be sure that there are no pre-emption rights, which might require shares to be offered to current shareholders before they can be transferred to ANY other party (including the company). These would need to be complied with before the company could buy back shares.
Take away
Given how straightforward it is to issue shares, it is surprisingly complicated to remove those shares. Working through the areas listed above will help focus a company’s mind on which is the best route to follow.
Helen Curtis is an associate in the London company team and regularly advises both companies and their shareholders and investors on how to arrange share capital. Please do get in touch with Helen if you have any queries.