Dividing up shares of your business – whether it’s amongst your team or to investors – can be tricky. On the one hand, it’s an excellent way to attract investors and to offer compensation. On the other hand, it’s not something you should dish out on a whim. If done incorrectly, you could end up jeopardising your rights as a founder.
However, when executed properly, offering shares is a win for all parties involved. We’ve asked three business experts for their insights on the best way for business owners to leverage shares successfully.
What are the benefits of shareholder agreements?
As with many aspects of business, giving (and accepting) company shares comes with pros and cons. Here are some of the top benefits of share percentages, according to the experts.
1. Company growth
Daniel Frampton is an independent advisor at Acumen Financial. ‘The sale of shares means the company raises capital that can be used to springboard growth or invest in new areas.’ He explains, ‘This will hopefully result in greater future earnings.’
2. A seat at the table
‘All shareholders have the right to vote,’ Says Daniel, ‘and they also have the right to be treated fairly by the company – so are free to petition the court if they feel it appropriate.’
3. A slice of the pie
For Daniel (and the rest of us), the financial benefits of shares is a key driver. ‘One of the basic rights of even an ordinary share is the right to share in the profits of the company. These are often paid out via a dividend distribution. Each individual share from the same class will pay the same dividend. The larger the holding of shares, the greater the quantity of dividends paid and therefore the greater the remuneration received by the shareholder.’
Of course, not everyone is guaranteed an equal piece of your business profits – or the same amount of influence. ‘Ultimately,’ Daniel explains, ‘the percentage of shares a shareholder owns dictates both the remuneration that the holder receives and the power they have over the day-to-day activities within the company.’
Then again, not everyone will take on the same amount of risk should things go wrong.
‘An individual with a larger holding bears a bigger risk to their personal finances than an individual with a smaller holding.’ Daniel points out, ‘Therefore, larger shareholders are often awarded greater benefits.
What do different share percentages mean?
When giving out (or accepting) shares, it’s vital that you understand how each percentage can impact your business dynamic.
Oliver Woolley is CEO of Envestors, the UK’s most active Angel Network. He recommends agreeing on share ownership with any business partners right from the start – only if applicable.
‘If you start a new company on your own,’ Oliver explains, ‘you will be the sole director and shareholder owning all 100 ordinary shares. This means you own 100% of the company. If there is more than one of you starting a company, you will need to agree on who owns what percentage of the shares of the company. It could just be as simple as dividing the shares equally between you – for example, 25% each if there are four of you.’
This approach works well if you want everyone to be on equal footing regarding decisions. Each share gives its holder one vote. Here are some other important percentages to consider:
‘With a greater than 5% holding,’ Says Daniel, ‘the shareholder can propose resolutions to problems within the company. But only with a greater than 10% holding can the shareholder call “extraordinary general meetings” perhaps to resolve a crisis or to hold a board of directors accountable for an event.’
Stephen Newman is Head of Corporate at Ramsdens Solicitors and specialises in shareholder advice. ‘‘Shareholders with less than 10% of the company’s share capital are vulnerable to losing their shares pursuant to a general offer to shareholders made by a would-be purchaser.’
‘Shareholders with more than 25% of the company’s votes can block a Special Resolution.’ Says Stephen, ‘The ability to do so has value.’
In order to maintain controlling interest, you’d need to own at least 51 percent of shares. ‘Shareholders with more than 50% of the company’s votes control the composition of the company’s board of directors,’ Stephen states, ‘and can thus influence the board to act in accordance with their wishes.’
If your company isn’t public, it’s possible for one person’s share ownership to pass the 75% mark – which gives the ability to pass a special resolution. ‘Shareholders with the ability to pass a special resolution can amend the company’s Articles of Association, if they wish,’ Says Stephen, ‘and can instruct the company’s directors to act in accordance with their wishes.
These are share percentages to be aware of when debating how much of your company to offer up. Now let’s examine some overall pointers you should take into account.
What are important factors to consider when handing out shares?
When distributing shares, you might think that starting small is the way to go. However, Stephen warns start-up founders to be wary of offering small shareholdings (to employees, for instance) as these can still sway the balance of power.
‘Suppose the company has two equal shareholders, who each decide to give 1% of their shares to a key employee.’ He says, ‘That employee now holds the balance of power in that – with the support of one shareholder – they can remove the other shareholder from office as a director of the company.’
Here are some more key factors you should think about:
1. Controlling Interest
In order to retain controlling interest, you’d need to hold more than 50 percent of shares. But this is only possible if your company hasn’t gone public yet.
‘Most stock exchanges don’t allow a single shareholder to own more than 30% of the company (e.g. LSE).’ Says Daniel, ‘So whenever a company has a single shareholder with controlling interest, you can assume that it’s a private company. For example: Ben Francis’ holding in his popular clothing brand Gym Shark.’
This means if you want to take your company public, you’ll need to give up controlling interest. It’s doesn’t necessarily mean you’ll lose influence, though.
‘Public companies like Tesla and Amazon have founders with relatively large shareholdings.” Daniel points out, “Elon Musk owns 17% of the EV manufacturer and Jeff Bezos owns 10% of the logistical giant.’
2. Blocking Rights
‘If adopting Model Articles,’ Says Oliver, ‘any single person or group of shareholders with more than 75% of the company can pass a “special resolution” to make changes – which could include dismissing a director. Or put it another way: anyone with 25% or more of the share capital can block any changes to the articles (referred to as “blocking rights”).
3. Future Valuations
‘Most founders want to grow their company whilst retaining the original ethos and mission.’ Daniel acknowledges, ‘If that can be done successfully, the next thought might be about valuation. The question at that point would be: is it better to own 50% of a £1 million company, or 10% of a £10 million company?’
4. Specific covenants
Ordinary shares are most commonly given out (that grant one vote per share). However, there are numerous other share options that can be offered – and you can even create your own new share class.
‘Ultimately’ Says Daniel, ‘shares can be given out that have a right to receive a dividend, but no right to vote. In this instance, a founder could retain voting power but have the ability to remunerate the shareholders.’
5. Tax Implications
Unlike earned income, share options aren’t subject to national insurance and income tax. Instead, the shareholder will pay Capital Gains Tax.
‘Income tax is levied at 20%, 40% or 45% depending on earnings,’ Daniel states, ‘whereas Capital Gains tax is levied at the much lower rate of 10% or 20%. This means that those who benefit from share remuneration potentially receive large tax advantages.
When executed properly, a shareholder scheme is an excellent way to compensate all parties involved in your business – while moving the company forward.
Owning shares in a business will motivate people to take a personal interest in its success. And with a clear understanding of how shareholder percentages work, business founders can create share options that work for everyone.
Want Some Help With That?
Share options are just one of many ways that you can compensate yourself and others.
To discuss the most efficient way that remuneration could work in your specific situation, get in touch with us today!