The process of issuing shares is critical for the growth of many businesses, allowing them to raise capital, attract investors and reach strategic milestones. However, it is vital that businesses are aware of the legal process that must be followed to issue shares and adhere to financial services legislation, avoiding legal pitfalls and optimising the benefits of share issuance.

In this article, we explore some of the key considerations for issuing shares. Remember that you should always seek professional advice when doing so.

What are shares?

Shares are units of equity ownership in the stock of a company. Every person who has shares in a company is a shareholder.

If a company is limited by shares, its ownership will be divided into certain percentages. 100% of the company is the whole pie, and each percentage represents a different portion of the pie. These pieces of the pie are called shares. Each share is a unit of ownership, which adds up to 100% ownership of the company.

Not all companies are limited by shares. There are other forms of companies, including companies limited by guarantee, but for the purpose of this article, we will be focusing on companies limited by shares.

What do shares mean?

Shares are important because they dictate ownership and control of a company, as well as the split of financial rights (e.g. dividends that come with ownership).

Different classes of shares can also exist (the company’s articles of association will usually specify whether this is the case). Generally, each class of share will have a different set of rights attached to it.

For example, an ordinary share usually gives the holder a right to one vote per share, equal rights to dividends, and the entitlement to participate in a distribution arising from the company’s winding up. Another class of share may entitle the holder to financial rights but not give them a right to vote.

A company can issue endless different share classes, each with its own unique characteristics.

Why do companies issue shares?

A company may want to issue shares for a host of reasons, including:

Raising capital: often, companies issue shares to investors to raise funds, help expand, invest in new equipment, or for R&D or product development
Reducing debt: a company can issue shares to pay off existing debt, improving the company’s balance sheet and making it more appealing to other investors
Incentivising employees: issuing shares to employees can help retain and attract talent
Attracting new business partners: issuing shares to people outside of the company can bring in new business partners with expertise or valuable networks.

Ultimately, who shares are issued to and the reasons for issuing them will depend on a company’s strategic and financial goals, as well as the broader market environment.

Restrictions on the issuing of shares

A company may set out restrictions in its articles of association and shareholders’ agreement. Typically, this may include a restriction on the number of shares that can be issued.

Additionally, under the Companies Act 2006 (the Companies Act), there are rules that set out how authority is provided to the directors to allot shares and statutory pre-emption rights (rights of first refusal) of the existing shareholders (detailed further below). These will all need to be considered and potentially addressed prior to issuing any shares.

Whereas ‘issuing’ shares means creating new shares and making them available, the ‘allotment’ of shares is the process of assigning these new shares to specific shareholders, thus formalising their ownership.

The Companies Act prohibits a private limited company from issuing shares to the public.

Directors’ authority

To issue new shares, directors must have authority to allot them. The default position, as set out in section 550 of the Companies Act, is that directors of companies with only one class of shares have the authority to allot additional shares, unless the articles of association state otherwise.

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Section 551 of the Companies Act deals with companies with more than one share class. Directors of these companies need express authority from an ordinary resolution passed by a simple majority vote of the company’s shareholders before they can issue further shares. This resolution can either be passed at a general meeting or, more commonly, using the written resolution procedure.

What are pre-emption rights?

Subject to a few exceptions, existing shareholders have statutory pre-emption rights whenever new shares are created. This means existing shareholders have the first right to buy these shares if they wish to do so under sections 561 and 565 of the Companies Act.

Pre-emption rights may be useful for shareholders as they can allow shareholders to protect their shareholding from dilution on the issue of new shares. Shareholders can also use pre-emption rights to block new, unknown investors from obtaining ownership of the company and potentially negatively impacting the business. This is because they can provide the funding to the company themselves before new investors arrive.

Offering shares to the public

Separate from the above, there are further restrictions on private companies offering shares to the public. First, the Companies Act restricts private companies from making offers to the public. In broad terms, the restriction relates to offering shares generally to the public, not offers to specified individuals. Additionally, an offer of shares is likely to be seen to be communicating a financial promotion, which is prohibited by the Financial Services and Markets Act 2000 (FSMA) unless an FCA-authorised person has authorised the offer or the offer is exempt (e.g. by being made to exempt categories of high-net-worth or sophisticated investors). These rules need to be navigated carefully, as a breach of the restrictions in FSMA is a criminal offence.

The following structures are commonly used that allow private companies to offer shares to specific groups of investors without falling foul of the restrictions relating to public offering and under FSMA. These exemptions include:

High-net-worth individuals: individuals that meet the financial threshold outlined in FSMA, such as having an annual income exceeding £100,000 or net assets (excluding their primary residence) exceeding £250,000
Sophisticated investors: individuals with the experience and expertise to evaluate the risks associated with investment opportunities, as defined by FSMA
Private placements: offers made to a limited number of people or entities (fewer than 150 persons per member state under the Prospectus Regulation), typically including professional investors
Employee share schemes: shares issued to employees as part of remuneration or incentive plans, which are also excluded from public offering rules

Such issuances must comply with specific legal and regulatory requirements to ensure that they do not inadvertently constitute a public offering or require a prospectus.

What is share dilution?

Unlike share transfers, a share issue can impact all existing shareholders by diluting their ownership of the company.

Here is an example of how share dilution might happen in practice:

Shareholder A has 10 shares of the company’s 100 shares, which means Shareholder A owns 10% of the company
The company then issues further shares to a new investor: Shareholder B. Now there are 200 shares in the company. Of these 200 shares, Shareholder B has 100, and now owns 50% of the company
Shareholder A still has 10 shares, but these are out of 200 rather than 100. This means that Shareholder A now only owns 5% of the company, instead of 10%

How to issue shares

Generally, the process for issuing shares will depend on the company’s existing share capital and articles of association.

First, the directors will need to determine how much capital they need to generate, as this will dictate the number of shares that need to be issued.

If neither the articles of association nor section 550 of the Companies Act authorises the directors of a company to issue new shares or the full amount necessary, the directors will need to obtain an ordinary resolution of the members, authorising them to do so.

If pre-emption rights apply, the directors will need to:

Obtain waivers from all shareholders waiving their right to pre-emption
Obtain a special resolution of the shareholders disapplying pre-emption rights in relation to the issue
Follow the pre-emption procedure

If there are no other restrictions set out in the articles of association or any shareholders’ agreement, the shares to be issued can then be offered externally – for example, to new investors.

The usual process is that the new shareholder will make an application for shares to the company or, in some cases, enter into a subscription agreement, in addition to a deed of adherence to any existing shareholders agreement. Once they have done so, and the company has received the money for the shares in full, the shares can then be issued.

The issue and allotment of shares is documented by the directors in a board resolution or meeting minutes. After this, they must provide details of the allotment to Companies House on the Return of allotment of shares (SH01 Form). This must be filed no later than one month after the allotment of company shares.

The directors are also obliged, among other things, to:

provide share certificates to the new shareholders
update the statutory register of members, and
notify Companies House of any changes to shareholder details on the next confirmation statement

The above covers a very basic issue of shares and the process may be significantly more complex where there is a shareholders’ agreement or your company has institutional investors or additional restrictions in the articles of association.

If you would like to know more about issuing shares, speak to a corporate solicitor at Linnear Legal.

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