Selling shares in a limited company in order to raise funding for it, is known as equity finance. One of the advantages of raising money this way is that you won’t usually pay interest or make repayments on it like you would with a bank loan or an overdraft.
Why would someone want to buy private company shares?
Although people often associate shares with the stock market, a private limited company can issue shares in return for an investment in the business.
When a person has shares in a company they own part, or a ‘share’ of it. As a shareholder, they will also receive a share of any profits. This is usually done by paying the shareholder with something called a dividend.
Dividends are paid from the profits that a company makes. If no profit is made, then no dividend is paid. The dividends are paid according to how much of the business the shareholder owns; that is, the percentage of shares they hold. Shareholders may have to pay tax on income they receive from dividend payments.
Watch our video to learn more about how dividends work.
Who can buy shares in a private limited company
The shareholders in a private limited company are often friends or family, though other investors can get involved too. These might be individuals, or the investment could come through a more formal equity funding agreement. For example, from a venture capital firm or a business angel.
Business angels are people or organisations who invest in businesses, but who might not otherwise have a connection to the business.
The company might decide to issue different classes of shares, to different types of investor. We wrote an article about different types of share class, though be careful not to confuse them with the different types of share, which we explain below!
What are the different types of shares?
There are four types of shares; preference shares, ordinary shares, redeemable shares and cumulative preference shares.
The different types of company shares
These are the most common type of share, giving the shareholder one vote for each share. The ordinary shares don’t have any special rights or restrictions. Although they may provide the best financial gain, they also have a high risk.
An individual with a preference share will have the right to be paid before any other share type. Essentially it means they get preferential treatment. If the business is wound up, this type of shareholder is paid before other types of shareholder.
Cumulative preference shares
A cumulative preference share gives the shareholder the right to be paid a dividend on the following year, if there is no profit in the current year.
These can be bought back by the company at a later date. This is either a fixed date or when the company chooses.
How are shares sold?
When an individual sells one or more shares to another person it is called a stock transfer. The buyer pays the owner for the value of each share, and the existing owner completes and signs a stock transfer form. They gives this and any share certificate to the new share owner in return for payment of the agreed price.
We’ve written a guide to transferring shares, which you can download by clicking the link below.
While complying with the company’s articles, the directors must approve the share transfer and make sure that the share register is amended.