What's share capital?
‘Capital’ is a term used to describe the funds that are available to run a company’s business. If someone says their business needs an ‘injection of capital’, what they mean is that they need more funding or finance.
One way that a company can raise funds is by issuing shares to investors. In law, the term ‘share capital’ is used to describe the money raised in return for issuing those shares. Share capital is contributed by investors (who become shareholders in the company) and it's represented by the shares that are issued to them.
What are shares?
If you think of the ownership of your company like a pizza or a cake, shares are the slices of that pizza or cake.
When you allocate shares to someone, you make them a shareholder (and part-owner) of your company. Share certificates are like the receipts that investors/shareholders are given in return for the money that they pay to become a shareholder.
As you take on more investment funds, you allocate more shares and the size of the slices you’ve allocated so far will alter.
When you start, you own 100% of your business. If you then take on 2 investors, each contributing some money in return for shares in your business, your ownership will be diluted from 100% to a lower percentage figure. The difference will be shared, proportionately, between your two new investors.
We explore how share ownership changes, and how you can create your own table recording changes in your share capital, (called your ‘cap table’) in our how-to video guide on building your own cap table
Why do investors like shares?
We asked Lucy from Wilkes to tell us more about shares and investor motivations for wanting them in your company.
Lucy told us that shares “are often referred to as a ‘bundle of rights’".
“The investor puts money into the company and, in return, they become a part-owner of that company (a shareholder). The investor gets ‘shares’ and these shares give them certain rights and entitlements as an owner of the company.”
What are those rights?
“Ah”, says Lucy, “well, there are different rights and you can combine them in different ‘bundles’. For example, your investor may well:
1. get a right to vote at shareholder meetings;
2. become entitled to dividends – these are rights to receive a share of the profits in your business, once you start making them; and
3. become entitled to a share in any surplus assets of your company, if you end up shutting it down.”
“Different investors will have different motives for investing in companies,” Lucy points out, “but most will want to make money (called ‘a return on their investment’) in several ways...
... firstly, by getting income from those dividends ... and, secondly, obtaining a lump-sum gain once they sell their shares for a profit (assuming your company has grown in value and so the investor’s individual shares representing a part share in the company have therefore grown in value by the time they come to sell).
“Think of it a bit like the shares growing in value like money you place in a bank earns interest – except if your company is doing well, it will be a much bigger return than what you get as interest on an ordinary bank deposit!
“What your investor wants is the value of their original investment back, with a lot of interest.”
Investors will want to know what rights you're offering in return for their investment money.
Different ‘classes’ of shares may carry different rights, and we've set out some typical examples of different share classes below (see the section entitled 'different classes of shares').
Before we look at the different classes of shares that you could offer in your company, let’s bust some of the other terms that you’ll need to understand when it comes to issuing shares.
What does ‘nominal’ or ‘par’ value mean?
The terms 'nominal value’ and ‘par value’ are used interchangeably and essentially mean the same thing.
All shares in limited companies that have a share capital must have a fixed nominal value.
Companies often fix the nominal or par value of their shares at £1 or 1p.
The nominal value represents a unit of ownership rather than the actual value of the share.
So, the nominal or par value is the minimum payable subscription price for that share (in other words, the minimum amount the shareholder must pay to your company for that share).
By law, you can't issue a share for a price that's less than its nominal value (You can issue a partly paid share – but don’t normally do this, as the company can call for the balance at any time).
You can, however, issue a share at a price that's more than its nominal value – and, if you do, the excess will be called the ‘share premium’.
Here’s an example to illustrate this, especially designed by Lucy for this guide:
Katie decides to set up a company on her own.
• to set up the company with 10 shares that will all be held by her • the nominal value of those shares will be £1 each and • the shares will be issued to her at par value
So, Katie pays a total subscription price of £10 to the company in return for the shares.
Right now: the company’s share capital consists of 10 shares of £1 each, all of which are held by Katie. She owns 100% of the share capital in the company.
A year later, Katie decides that the company requires an ‘injection of capital’. She finds an investor, Daniel, who's willing to invest £50,000 in her company.
Katie has worked hard in the business and it has grown substantially.
She takes some advice and concludes that the market value of the shares in her company has increased significantly. So, she agrees with Daniel that he'll invest £50,000 in return for 5 shares of £1 each (i.e. he will pay £10,000 per share).
The nominal value of those shares will still be £1 (he will still get 5 shares of £1 each).
But, Daniel will pay a premium on those shares of £49,995 in total.
After the investment: the company’s share capital will comprise 15 shares of £1 each, 10 of which are held by Katie and 5 of which are held by Daniel.
Katie now holds just over 66% of her company. Daniel holds just over 33% of it – but, as the business has really grown in value, Daniel has had to pay a lot more for his 5 shares.
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