There are many differences between ordinary shares and alphabetical shares and it can become confusing and frustrating for a business to understand which is best for them.
An ordinary share represents the basic voting shares of a corporation. Typically, holders are only entitled to one vote per share and they do not have any predetermined dividend amount. An ordinary share represents equity ownership in a company proportionally with all other ordinary shareholders, according to their percentage of ownership in the company. All other shares of a company's stock are, by definition, preferred shares.
Ordinary shareholders have the right to a corporation's residual profits. In other words, they are entitled to receive dividends if any are available after the dividends on preferred shares are paid. They are also entitled to their share of the residual economic value of the company should the business unwind; however, they are last in line after bondholders and preferred shareholders for receiving business proceeds. As such, ordinary shareholders are considered unsecured creditors.
While they face greater economic risk than creditors and preferred shareholders of a corporation, they can also reap greater rewards. If a company makes large profits, the creditors and preferred shareholders are not paid more than the fixed amounts to which they are entitled, while the ordinary shareholders divide the large profits among themselves. The same occurs when companies, such as start-ups, are sold to larger corporations. The ordinary shareholders usually profit the most.
The only obligation that an ordinary shareholder has, is to pay the price of the share to the company when it is issued. In addition to the shareholder's right to residual profits, he is entitled to vote for the company's board members (although some preferred shareholders may also vote) and to receive and approve the company's annual financial statements.
But what about alphabet shares?
Alphabet shares are just shares of different classes, often set up as 'A' shares, 'B' shares, 'C' shares, etc. The classes often all have an equal footing; for example, the same voting and rights on winding up. But they may also carry different rights, for instance entitlement to a preferential set dividend or limited rights to vote at general meetings.
Alphabet shares are certainly something to consider if the company is growing and expanding. Dividends are received by all the shareholders of a Limited Company, in proportion to their personal shareholdings. Should there be a need for one shareholder to be paid a different amount to the other shareholders, there either needs to be a dividend waiver or the share structure needs to be amended.
Alphabet shares allow freedom and flexibility in paying dividends, so payments can be made to a certain class of share without having to pay the same amount in dividends to each company shareholder. If your Limited Company’s shareholders are taxed at higher rates than one another (if at all) then alphabet shares are a particularly good idea. Alphabet shares also do not need the consent of all shareholders.
The “settlement” rules:
Care needs to be taken to ensure that the arrangement is not caught by the settlement legislation. The relevant clauses are in Chapter 5 of Part 5 of ITTOIA 2005; s620 defines a settlement widely as including “any disposition, trust, covenant, agreement, arrangement or transfer of assets”. Therefore, within owner-managed companies a settlement may apply where an individual enters into an arrangement diverting income one to another, resulting in a tax advantage.
When considering alphabet share structures, it is particularly important to reorganise the shares correctly; a lack of voting rights, for example, will mean that the shares will be “wholly or mainly a right to income” and be caught (s626 ITTOIA 2005).
To conclude, although alphabet shares are flexible and potentially more effective for a growing company than ordinary shares, if you are to use them, you must ensure you are using them correctly to avoid falling foul of HMRC rules.