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If you’re new to the world of limited company ownership, then you may have heard people speak knowingly about “equity”, but not been exactly sure what this means.

As there are opportunities for businesses in the way that they use equity, we thought we’d produce a post that looks at the whole equity subject and give you some tips that may be helpful.

What are equities?

In its simplest form, equity means the value of a business. This value is split up amongst shareholders when the company issues shares.

Many companies only have one shareholder in the early days, who tends to be the owner and operator of the business. In fact, plenty of companies are set up with the intention of staying at that level. For instance, consultants, interim managers, and technical specialists will work in this way.

Although the company is legally separate, in everyday life the person who holds the shares is the same as the person who does the work. In that respect the company ‘feels’ just like a sole trader business.

As a result, the idea of owning shares in your own business can be very theoretical. After all, you have too much to do running the business on a day-to-day basis to be worrying about shares.

The differences between a limited company that has equity and a sole trader who does not become more apparent when the company grows and starts to issue shares to other people.

Although the term “equity” relates to the value of a business, “equities” is a word that relates to shares.

So, you can own equities in a business and as a result, you’ll own part of the equity of the business. Clear as mud! Bear with us.

Different types of equities

The vast majority of shares that are in circulation are ordinary shares. This is the simplest form of shareholding, and it is probably the most common because these are what you use in the model Articles of Association when you set up a limited company.

A company can authorise as many shares as it likes, at whatever price it wants to.

Issuing and authorising shares

The application form to register a limited company includes a statement of capital which details all of the shares actually issued at incorporation (the registration of limited company). These shares must be issued at the time rather than keeping any back to issue later, but you can allot and issue more shares as and when you need to.

Ownership in a limited company

Ownership of the company relates to the percentage of issued shares that people hold. So, in our £100 company, someone who owns 100 shares is the 100% owner. Someone who has 70 shares owns 70%, and so on.

If you hold 70% of the shares, you are entitled to 70% of any dividends the company declares, and 70% of any proceeds from the sale of the business (known as participation).

Because you own more than 51% of the capital you are, to all intents and purposes, the owner of the business. This is because you can outvote anyone else at a general meeting.

That’s where the simplicity ends, because issuing types of company shares can get very creative indeed.


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Different types of shares

In general, the different types of shares used in a company boil down to a few examples.

Type of share What it entitles the shareholder to
Ordinary shares Voting rights, and the right to participate
Capital only shares A share of the proceeds of sale or liquidation
Preference shares Capital and the first rights to any dividends before other shareholders
Voting only Control of the business, but no rights to dividends or capital
Dividends only A share of the profits, but not capital or voting rights

Companies will sometimes have complex combinations of share types, giving different classes of shareholders different rights. These are sometimes known as alphabet shares, because of the way that different share classes are recorded.

Classifying shares like this can be extremely useful. For example, issuing dividend only shares to reward employees for their work, without giving them any control of the business.

The way to tell what rights a particular share class has, is to examine the shareholders’ agreement of the company in question.

Using equity in a company

As well as showing who is entitled to what within a company, shares can also be useful for other reasons, such as raising money or motivating employees.

Issuing shares to raise money

Known as equity finance, selling shares in order to raise funds for the business is actually fairly common.

You can sell shares to anyone you like, although you do need to be careful about how you describe them. There are strict rules about promoting investments!

If you want to introduce cash into your business but don’t want to give up any control, then the company can authorise preference or investment shares. This means that the shareholder can receive their share of any dividends that the company declares, but they won’t have any voting or controlling rights.

Often, businesses that want to bring in a lot of cash to fund aggressive growth plans will do so through Private Equity (PE), Venture Capital (VC) or business angels. Typically, this will involve the investors taking a part of the company (and sometimes a very large part) in return for a big influx of cash.

Giving shares to employees

Some companies issue shares to employees as a reward for good performance, or as a loyalty scheme. You might also offer a share purchase (SAYE – Save As You Earn) scheme.

The opportunity to earn equity within a company is especially helpful when the business is very new. A company that has a rapid growth profile may choose to offer a lower base salary when cash is tight at the start. It can then supplement this by awarding equity which means key employees have a valuable stake in a growing enterprise. It can help you attract talent before you can afford the salary they might normally expect.


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The downside to equity investment

Whilst there are lots of reasons why authorising different shares of various types is useful, like all business decisions there are downsides.

The financial impact

The most obvious disadvantage is that giving away a percentage of your shares means you’re giving away a percentage of your own equity, and therefore any dividends that comes with it.

Known as ‘dilution’, this is the eternal trade-off for business owners. Is it better to own less of a bigger company or all of a smaller one?

What it means for control of the business

Alongside the benefits of owning equity in a business, when you sell shares, you are usually selling some of your control.

In many cases, this won’t matter as long as the total that you own is still 51% or more. But sell more than 50% of your business, even if it’s to different shareholders, there’s always a chance they could band together and fire you from your own company!

Shareholders rights

Shareholders have rights when they invest in a company. When you own all of the shares then to a large extent you can do what you please. If someone else has some equity, then you also have to take their needs into account.

A good example of this in practice is declaring dividends. If shareholders own the same class of shares, they receive dividends at the same rate, according to how much of the company they own.

For instance, there are 100 shares in a company, and two shareholders; one who owns 70 type A shares, and another who owns 30 type A shares. Any dividends are split 70/30 – you can’t just keep it all for yourself!

Extra shares mean extra admin

The company is legally required to hold a register of shareholders and make this available for inspection. You also need to hold general meetings to discuss important matters regarding the company.

Whilst a sole shareholder can convene a meeting in the local pub if they wish, the more shareholders you have, the more formal these meetings have to become.

Share structures can get very complex and with greater complexity comes greater cost. We wouldn’t ever advise that you make up your own shareholders’ agreement, so you’ll need someone qualified and experienced to do this for you.

This means the process can take longer and cost more, but the consequences of getting it wrong could be disastrous.

Should I sell equity in my company?

So, is it a good idea to sell some of the equity you own in your business? It’s difficult to say one way or another, because every company is different.

What we can say is that introducing equity is useful if you want to bring cash into the business, especially in the early days. It’s also helpful if you want to reward key staff but don’t have the cash to give out large bonuses.

But with every good thing, there are always some downsides.

Selling equity increases your responsibilities to the other shareholders, and can mean your company secretary function must become more professional. Diluting the value of your shareholding also means that you get a lower percentage of any dividends and eventual sale proceeds. And of course, if you sell off shares with voting rights you will lose some of the control of your business.

Our advice is to speak to a professional before you decide on any course of action!

Learn more about our online accounting services for limited companies. Chat to the team on 020 3355 4047, or get an instant online quote

About The Author

Lena Cunningham

I'm a Marketing Executive with a passion for all things creative and design. I graduated from Chester University in 2019 with a first class degree in Illustration with Animation.

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