Limited companies can use their leftover profits after tax to make dividend payments to their shareholders. These dividend payments can be for different amounts depending on what type of shares the shareholder owns in the business. In this article we explain how dividend payments can be paid out for unequal amounts depending on what each shareholder is entitled to.

How do dividends and shares work?

Limited companies are owned by their shareholders who, literally, hold a share of the business. Some shareholders might own more shares than others, which means that they own different percentages of the business (in accounting terms you might see this referred to as their share of the company’s equity).

Owning shares usually means the shareholder is entitled to receive dividend payments from the company’s profits based on the percentage of shares they own. Someone who owns 30% of a business’ shares will usually receive 30% of the profits, for example. Working on this basis can help to ensure that shareholders get a proportional amount according to their investment in the business.

This assumes all of the company’s shareholders own the same type of shares, but there might be times when a company wants to pay them in a different way. Creating different classes of shares, sometimes called alphabet shares, allows a company to do this.

Why are different classes of shares called alphabet shares?

The term alphabet shares describes the different classes of shares that can be issued by a limited company. They tend to be labelled in the company’s accounts and articles of association as A shares, B shares, C shares and so on, hence the name alphabet shares!

Why create different share classes?

Creating different share classes means each type can be assigned different rights. These could be voting rights, or the percentage of dividends the shareholder of that particular class of share is entitled to.

For instance, an ‘A share’ shareholder might be paid dividends at a different rate to a ‘B’ shareholder. A ‘C’ shareholder may not have the same voting rights as a ‘B’ shareholder. This means you could have a variety of shareholders with very different dividend pay outs and voting rights.
 

What are the benefits of paying different dividends out?

If you’re just dividing by share ownership, the benefit is that it’s a fair and simple way of dividing company profits. But what about alphabet shares?

 
It lets the company move beyond a pro rata basis of ownership, and instead pay shareholders based on their involvement or investment in the company.

• You might want to appoint family members as shareholders but not give them voting rights. For instance, if you have children who you would like to receive dividends, but they don’t need to make decisions about the business.
• Or, you might invest in a startup and own the majority of it without being involved in day-to-day operations. In that case, it might be agreed that the other directors will receive a larger share of the profits, whilst you still own most of the company.

Creating alphabet shares can become really useful in this sort of situation, giving you more control over who can influence the business.

What does this mean for tax?

Shareholders who receive dividend payments may need to pay Dividend Tax on this type of income. The amount of income they receive in a tax year, and the amount of dividends they earn, affects how much Dividend Tax they need to pay.

How do I set up different classes of shares?

You’ll need to tell Companies House about the shares in your business when you first incorporate the company, or if you allot more shares later on. They’ll also need to know the details of each shareholder and what it is that they hold.

The details of what your shareholders (and different types of shares) are entitled to should be recorded in the company’s Articles of Association. This document is a bit like having written rules which set out how to run the company.

 
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