What Are Ordinary Shares? A Complete Guide Under the UK’s Companies Act 2006

When establishing or investing in a UK company, understanding what are ordinary shares is fundamental to grasping how corporate ownership and control operate. In the UK, a limited company is the most common legal structure and its share capital mostly consists of ordinary shares. As a corporate solicitor with extensive experience in company law, I regularly advise clients on the intricacies of share structures under the Companies Act 2006. This comprehensive guide will explain everything you need to know about ordinary shares, their rights, the different types of shares available under UK company law, and how they fit within the broader landscape of UK company law.

What Are Ordinary Shares?

Ordinary shares represent the most common form of equity ownership in UK companies (also known as common shares or equity shares in some jurisdictions). Under the Companies Act 2006, an ordinary share is defined as a share that carries unrestricted rights to participate in distributions (both dividends and capital) and to vote at general meetings of the company.

In essence, when you hold ordinary shares in a company, you are an owner of a portion of the company’s shares. These shares give you a stake in the company’s profits, assets, and decision-making processes. The Companies Act 2006 doesn’t provide a rigid definition of what constitutes an ordinary share, but rather focuses on the rights attached to shares, allowing companies considerable flexibility in structuring their share capital.

Ordinary shares are typically issued when a company is first incorporated, and they form the backbone of most UK companies’ capital structure. Different types of shares can have different rights, such as voting, dividend, or capital rights. Unlike other types of shares that may have specific restrictions or enhanced rights, ordinary shares provide their holders with the standard package of shareholder rights that we’ll explore in detail below. The value of a company’s shares is often a key factor in company valuation events such as acquisitions or IPOs.

Who Are Ordinary Shares For?

Ordinary shares are suitable for a wide range of investors and business owners, each with different objectives and risk appetites:

Entrepreneurs and Founders: When starting a business, founders typically hold ordinary shares as they provide full participation in the company’s growth and control over strategic decisions. Holding ordinary shares aligns the founders’ interests with the company’s success, as their financial outcomes are directly tied to how well the company performs.

Angel Investors and Venture Capitalists: Early-stage investors often acquire ordinary shares to benefit from potential capital appreciation. These investors invest money in ordinary shares to participate in the company’s growth and share in its success. However, sophisticated investors may negotiate for preference shares or ordinary shares with enhanced rights to protect their investment.

Employee Share Schemes: Many companies issue ordinary shares to employees through various schemes such as Enterprise Management Incentives (EMI) or Share Incentive Plans (SIP). This approach helps align employee interests with company performance whilst providing potential tax advantages.

Retail Investors: For publicly traded companies, ordinary shares are the standard investment vehicle for individual investors seeking exposure to a company’s performance through dividend income and capital growth.

Family Members: In family businesses, ordinary shares are commonly held by family members who wish to participate in both the financial returns and governance of the business.

The flexibility of ordinary shares makes them appropriate for most scenarios where investors seek to invest money and participate in a company’s success without complex rights structures.

Nonetheless, creating different classes of shares for different categories of recipients is very much advisable. Creating different classes of shares allows the company and its shareholder to grow, receive profits more tax efficiently, and for the founders to maintain control.

What Rights Do Ordinary Shares Have?

The rights attached to ordinary shares are fundamental to understanding their value and function within a company structure. Under the Companies Act 2006, these rights typically fall into three main categories:

1. Voting Rights: Ordinary shareholders usually have the right to vote at general meetings, influencing key company decisions.

2. Dividend Rights: Holders of ordinary shares are entitled to receive dividends, if and when they are declared by the company.

3. Capital Distribution Rights: In the event of a company’s liquidation, ordinary shareholders are entitled to a share of the remaining assets after all debts and liabilities have been paid. However, preferred shareholders have priority over ordinary shareholders in receiving payments during liquidation.

Voting Rights

Voting rights represent one of the most significant privileges of holding ordinary shares. The Companies Act 2006 grants holders of ordinary shares the right to vote on key company matters at general meetings.

Typically, each ordinary share carries one vote, following the principle of “one share, one vote.” However, companies can create different classes of ordinary shares with varying voting rights, provided this is clearly specified in the company’s articles of association.

You may also create different Ordinary shares, eg A Ordinary and B Ordinary shares. For example, founders could keep A Ordinary shares and specify, in the Company’s articles of association, that each A Ordinary share carries 100 votes, whilst B Ordinary shares only carry 1 vote per share.

Shareholders can exercise their voting rights on crucial matters including:

• Election and removal of directors

• Approval of major transactions such as mergers and acquisitions

• Amendments to the company’s articles of association

• Approval of directors’ service contracts exceeding two years

• Decisions regarding company liquidation or reconstruction

These matters are decided by a majority vote of shareholders present or represented at the meeting.

The Companies Act 2006 also provides for written resolutions, allowing ordinary share holders to make decisions without holding a physical meeting. This streamlined approach is particularly beneficial for smaller companies with few shareholders.

Dividend Rights

Dividend rights entitle holders of ordinary shares to receive a share of the company’s dividends, which are distributions paid out of the company’s profits to shareholders. Unlike preference shareholders who usually have fixed dividend entitlements, ordinary share holders receive dividends at the discretion of the company’s directors and shareholders. Preference shareholders are often entitled to a fixed amount or set amount of dividends, providing them with predictable returns.

The Companies Act 2006 establishes several key principles regarding dividend payments:

Distributable Profits: Dividends can only be paid from distributable profits, calculated according to the company’s most recent annual accounts. This protects creditors by ensuring that dividend payments don’t compromise the company’s capital base. The total sum of dividends paid to shareholders depends on the company’s profitability and dividend policy.

Director Recommendation: Directors must recommend dividend payments, which are then subject to shareholder approval at general meetings. However, shareholders cannot declare dividends exceeding the amount recommended by directors.

Equal Treatment: All holders of the same class of ordinary shares must be treated equally regarding dividend payments. This principle, known as “pari passu” rights, ensures fairness amongst shareholders.

Timing: Companies have flexibility regarding dividend frequency, with many paying interim and final dividends annually, whilst others may pay quarterly or at other intervals.

Tax Considerations: Dividend payments have specific tax implications for both the company and shareholders, including corporation tax relief for the company and dividend tax for recipients.

Capital Distribution Rights

Capital distribution rights become relevant when a company is liquidated or undergoes capital reduction procedures. Holders of ordinary shares are entitled to participate in any surplus assets after all debts and obligations have been satisfied.

The Companies Act 2006 establishes a clear hierarchy for capital distributions:

Priority Order: Generally, secured creditors rank first, followed by unsecured creditors, then employees, then preference shareholders (if any), and finally ordinary share holders. This means ordinary shares carry higher risk but also higher potential rewards.

Proportionate Entitlement: Ordinary share holders receive their proportion of surplus assets based on their shareholding percentage. If you hold 10% of the ordinary shares, you’re entitled to 10% of the distributable surplus.

Return of Capital: During the company’s lifetime, capital can be returned to shareholders through various mechanisms including share buybacks, capital reductions, and special dividends. Ordinary share holders participate in these distributions according to their shareholding percentages.

Liquidation Scenarios: Whether liquidation is voluntary or compulsory, the rights of ordinary share holders remain consistent, though the practical outcomes may vary significantly depending on the company’s financial position. The entitlements of shareholders are determined at the point of liquidation or capital distribution, which is especially important for redeemable preference shares where the timing of redemption is a key consideration.

Issuance of Ordinary Shares

When a company decides to raise capital, issuing some kind of ordinary share (A Ordinary, B Ordinary, C ordinary,…) is the most common type of approach used by businesses in the UK. By offering ordinary shares, a company is essentially inviting investors to become part-owners, sharing in the company’s profits, assets, and future success. This process is fundamental for both new and established companies, whether they are small companies seeking growth or large listed companies expanding their operations.

The decision to issue ordinary shares typically rests with the company’s directors, who must carefully consider the number of shares to be offered, the price at which they will be issued, and the overall impact on the company’s share capital. The price of ordinary shares is often determined by evaluating the company’s current earnings, assets, and market prospects, ensuring that the value offered to investors reflects the business’s potential.

To properly hand over ordinary shares to investors, companies must complete a very specific process to ensure compliance with the Companies Act 2006 and any other relevant regulations. This includes updating the company’s register of members, filing the appropriate statements of capital, issuing new share certificates, passing shareholder resolutions, and documenting board meeting decisions.

Ordinary shareholders who acquire these shares typically gain important rights, most notably voting rights. This means they can participate in major decisions affecting the company, such as electing directors, approving significant transactions, or amending the company’s articles of association. The influence of ordinary shareholders is a key aspect of corporate governance and ensures that ownership and control are closely linked.

One of the main distinctions between ordinary shares and preference shares (or preferred shares) lies in the way dividends are paid. Preference shareholders are usually entitled to a fixed percentage of the company’s dividends, receiving their payments before any dividends are distributed to ordinary shareholders. In contrast, ordinary shareholders receive dividends only after preference shareholders have been paid, and the amount is not fixed—it depends on the company’s profits and the directors’ decision to make a dividend payment. This means that while ordinary shares offer the potential for higher returns if the company performs well, they also carry a higher level of risk compared to preferred shares.

The issuance of ordinary shares can also have important tax implications. For example, dividend payments to ordinary shareholders may be subject to income tax, depending on the recipient’s personal tax situation.

Companies may choose to issue different classes of ordinary shares, each with its own set of rights and obligations. For instance, some classes of ordinary shares may have enhanced voting rights, while others might offer different dividend entitlements. This flexibility allows companies to tailor their share structure to attract various types of investors or to achieve specific business objectives, such as incentivising employees or maintaining control within a founding group.

For limited companies and small companies, issuing ordinary shares is often the primary means of raising capital to fund new projects, pay off debts, or support ongoing business operations. In the context of a listed company, ordinary shares—often referred to as common stock—are traded on the stock market, allowing a wide range of investors to participate in the company’s growth. The value of ordinary shares can fluctuate based on the company’s performance, market conditions, and investor sentiment.

In summary, the issuance of ordinary shares is a vital tool for companies seeking to raise capital and for investors looking to benefit from a company’s success. Ordinary shareholders gain voting rights and the potential to receive dividends, but they also accept a higher level of risk compared to preference shareholders. Companies must carefully consider their capital structure, the rights attached to different classes of ordinary shares, and the tax implications before proceeding with an issuance. For investors, understanding the benefits and risks of ordinary shares is essential for making informed investment decisions in the dynamic world of UK business.

Different Classes of Shares

The Companies Act 2006 provides companies with considerable flexibility in creating different classes of shares, each with distinct rights and characteristics. Different classes of shares, sometimes referred to as stocks, can be held by various types of holders, each enjoying specific rights and privileges. Understanding these variations is crucial for both investors and business owners structuring their companies.

Where Do You Detail The Different Classes of Shares?

Articles of association usually serve as the primary document defining share rights and classes within a UK company. Under the Companies Act 2006, articles of association must clearly specify:

Rights Attached to Each Class: The voting, dividend, and capital rights for each share class must be explicitly detailed. This ensures transparency and prevents disputes amongst shareholders.

Transfer Restrictions: Any limitations on share transfers, such as pre-emption rights or director approval requirements, must be clearly stated in the articles.

Variation of Rights: The procedures for varying or removing class rights must be specified, typically requiring special resolutions and class meetings.

Issue of New Shares: The articles should detail the authority for issuing new shares and any pre-emption rights existing shareholders may have.

The Model Articles provided under the Companies Act 2006 offer a standard template, but most companies adopt bespoke articles tailored to their specific requirements. As a corporate solicitor, I strongly recommend that companies carefully draft their articles of association with professional legal assistance to ensure all share classes and rights are properly documented and legally sound.

Statements of Capital filed at Companies House must also reflect the share structure, providing public visibility of the different classes and their associated rights.

Types of Share Classes

Beyond ordinary shares, UK companies can issue various specialised share classes, each designed to meet specific commercial objectives and to provide different rights to shareholders:

Preference Shares: These shares typically carry preferential rights to dividends and capital distributions but may have limited or no voting rights. Preference shares can be cumulative (unpaid dividends accumulate) or non-cumulative, and may carry fixed or variable dividend rates.

Redeemable Shares: The Companies Act 2006 permits companies to issue shares that can be redeemed (bought back) by the company at a future date. This flexibility is particularly useful for management buyouts, succession planning, or providing exit routes for investors.

Non-Voting Ordinary Shares: These shares carry the same dividend and capital rights as voting ordinary shares but without voting privileges. They’re often used when companies want to raise capital without diluting control.

Alphabet Shares: Companies frequently create multiple classes of ordinary shares designated by letters (A shares, B shares, etc.). This structure allows different dividend policies for different shareholders, which can be advantageous for tax planning and investment structuring.

Growth shares: Usually used for Family Investment Companies as part of succession (tax) planning. These carry the economic (right to capital distributions), either entirely or anything above a certain threshold (which usually would be set to be in line with how much the founder’s estate has left in tax-free allowance to pass to their children).

Management Shares: Sometimes called founder shares, these may carry enhanced voting rights or special appointment powers, allowing management to retain control even with minority equity stakes.

Employee Shares: Special classes designed for employee share schemes, often with restrictions on transfer and specific tax advantages under HMRC regulations.

Each share class must be carefully structured to achieve the desired commercial outcome whilst complying with the Companies Act 2006 and other relevant legislation. The complexity of modern share structures requires expert legal and tax advice to ensure optimal outcomes for all stakeholders. For comprehensive guidance on company structuring and share arrangements, it’s advisable to consult with specialists who understand both the legal and commercial implications.

To discover more resources, including checklists and practice notes on different types of share classes and their rights, explore our dedicated guides.

Conclusion

Understanding what are ordinary shares is essential for anyone involved in UK company structures, whether as an entrepreneur, investor, or advisor. Ordinary shares provide the foundation of corporate ownership, offering holders participation in company profits, assets, and governance through their voting, dividend, and capital distribution rights.

The Companies Act 2006 provides a robust framework that balances flexibility with investor protection, allowing companies to structure their share capital to meet diverse commercial needs whilst ensuring transparency and fairness amongst shareholders.

As corporate structures become increasingly sophisticated, the importance of properly understanding and documenting share rights cannot be overstated. Whether you’re establishing a new company, restructuring an existing business, or considering an investment, professional legal advice ensures that your ordinary shares and other share classes are structured optimally for your specific circumstances.

There is no definitive answer as to whether ordinary shares or preference shares are better, as the optimal choice depends on the specific needs and circumstances of the company.