Understanding Share Capital and Its Role in Business Growth
As a business expands, its financial requirements inevitably change, necessitating the adaptation of its share capital structure. Understanding when and how to modify share capital through methods like increases, decreases, splits, or consolidations is crucial for small and medium enterprises to optimize their financial strategies and operational resilience.
Share capital represents the money contributed by shareholders in exchange for an equity interest in a company. This capital is typically retained by the company until its liquidation. While share capital generally cannot be withdrawn or used as loan collateral, the shares themselves are transferable should a shareholder wish to exit the company. In Kenya, the alteration of a company’s shares is governed primarily by the Companies Act 2015 and the Insolvency Act 2015.
Key Types of Shares
Before exploring modifications, it is essential to distinguish between the various types of shares. Each serves a distinct purpose, catering to different investor preferences and corporate objectives, thus influencing the company’s relationships with its stakeholders.
- Ordinary Shares: Also known as equity securities, these confer voting rights, dividend entitlements, and rights to residual assets and capital. Holders of ordinary shares receive notice of shareholder meetings, where they can vote on matters such as electing the board of directors and approving significant corporate actions. They generally receive lower dividends compared to holders of preference shares. These are typically the shares traded on a stock exchange.
- Preference Shares: These shares commonly lack voting rights but offer a preferential claim to receive a fixed percentage of dividends and capital distributions before ordinary shareholders. A significant advantage is the prioritization of capital return should the company enter liquidation. Investors often favour preference shares if a fixed dividend payment is prioritized over ownership and voting control. They are beneficial when dealing with income oriented investors, risk averse investors, and for companies seeking capital from sources like venture capital or private equity.
- Redeemable Shares: A company issues these shares with the provision or intention to buy them back at a later date, funding the purchase from accumulated profits or the proceeds of a fresh share issue. This mechanism facilitates the repayment of principal share capital to the shareholders. Redemption can occur at an agreed value on a specified date or at the discretion of the directors, provided the company remains a going concern. This type of share appeals to investors and companies seeking flexibility in managing capital and shareholder composition, often advised for temporary capital needs or for shareholder liquidity.
- Convertible Preference Shares: A hybrid instrument that combines features of convertible and preference shares. They provide rights to a fixed dividend for a defined period, after which a decision can be made to convert them into ordinary shares or maintain their status. The conversion rate is documented in the company’s constitutional documents. This allows a shareholder to acquire ordinary shares at a potentially lower price and is suitable for income focused investors, as it helps raise capital without immediately diluting existing ownership and voting rights.
Shares can also be categorized into different classes, such as Class ‘A’ and Class ‘B’, to differentiate the rights and privileges among various holders. For instance, Class ‘A’ shares may be issued to the general public with full rights, while Class ‘B’ shares may carry preferential rights or specific privileges.
Procedures for Share Capital Alteration
To modify the share capital, shareholders must typically approve a special resolution, which requires a majority of at least 75% of the votes cast by those entitled to vote, either in person or by proxy, as outlined in Section 68 of the Companies Act. Alterations can involve increasing, reducing, splitting, or consolidating shares.
1. Capital Reduction
Supported by Section 407 of the Companies Act, a company may reduce its share capital to cancel unpaid share capital, cancel paid up share capital that is lost or not represented by assets, or repay paid up share capital that exceeds the company’s needs. Alternatively, a reduction may be approved by an ordinary resolution if the articles of association permit.
The procedures vary between public and private companies. A public company is required to apply for a High Court order, and its creditors are entitled to object to the reduction. For a private company, the capital reduction resolution must be supported by a solvency statement. The directors are required to execute this statement of the company’s solvency within fourteen days after the resolution is passed, in accordance with Section 421 1 of the Companies Act.
2. Share Split
A share split involves subdividing existing shares into a larger number of shares with a smaller nominal value. This also requires shareholder approval via resolution. The process makes the shares more affordable but does not change the total market value or the rights associated with the holding. For example, a company with 1,000 shares valued at Ksh 100 each could undergo a 2 for 1 split to yield 2,000 shares of Ksh 50 each.
3. Consolidated Shares
Consolidation combines several shares into a smaller number of shares, consequently increasing the nominal value of each share. This process must also be approved by the shareholders through a resolution. For instance, a 2 for 1 consolidation could transform 2,000 shares of Ksh 50 each into 1,000 shares valued at Ksh 100 each, maintaining the overall market value.
4. Cancellation of Shares
A company may cancel issued or unissued shares in specific circumstances, such as when forfeited or surrendered shares in a public company are not re allotted within three years, or in the case of a share buyback. While this reduces the total shares, the underlying circumstances differentiate cancellation from a general capital reduction.
5. Share Capital Increase
Guided by Section 63 of the Act, companies can increase their share capital to accommodate internal and external factors such as debt reduction, business expansion, or regulatory compliance. This alteration typically incurs a stamp duty payment of 1% on the amount of the additional share capital.
Conclusion
It is paramount that any alteration to a company’s share structure be formally accompanied by a shareholders’ resolution and a notification to the registrar detailing the reorganization. Companies should review their articles of association to confirm the authority and necessary approval level, such as an ordinary or special resolution, required for share capital alterations, ensuring strict adherence to both their articles and the Companies Act.
