Introduction
 
Selling shares in your company is one way of raising long-term finance for your business. This is also known as equity finance. The advantage of equity finance is that you don't have to repay the finance or pay interest on it as you would with an overdraft or bank loan.

Shares represent ownership in a company. When an individual buys shares in a company, they become one of the owners of the business. This entitles them to a share of the distributed profits of the company, known as dividends.

This guide will explain how shares are issued and sold, what dividends are and the tax implications associated with dividends.

What are shares and why are they issued?

Shares represent ownership of a company. When an individual buys shares in your company they become one of the owners of the company. Shareholders choose who runs a company and are involved in making key decisions such as whether a business should be sold.

While shares are most obviously associated with the stock market, the majority of small businesses won't go anywhere near a stock market in their lifetime. They are more likely to give out shares in their company in return for a lump-sum investment. This may either be from friends and family or, for businesses that are looking for capital to fund high growth, through formal equity funding finance.

Formal equity finance is available through:

• business angel investors
• venture capital firms
• stock markets

These investors are willing to put up capital for a share in a growth business. The advantage of raising money in this way is that you don't have to pay the money back or pay interest to the investors. Instead, shareholders are entitled to a share of the distributed profits of the company, known as dividends.

Selling shares in your company on a stock market can provide:

• new finance
• an exit for founding investors who want to realise their investment
• a mechanism for investors to trade shares
• a market valuation for the company
• an incentive for staff using shares or share options
• the business with an acquisition currency in the form of shares
• a way to raise your business' profile
  

How are shares issued?

When you set up a company, whether limited or unlimited, you can decide on the level of share capital - the company's authorised capital - and its division into fixed priced shares.

To set this up, draw up a Memorandum of Association.

This sets out:

• the amount of share capital the company will have 
• the division of the share capital

The founders of the company sign the memorandum and state the number of shares they want. These are then issued upon incorporation. The money paid for the shares - which can be the nominal value or more - must be retained by the company.

Family or friends
You may choose to issue shares to family or friends in return for investment in your business rather than accepting the offer of a loan from them. That way you're not obliged to make repayments. Formalising the agreement with family members or friends can avoid disputes that may arise in the future.

Employees
Employee share ownership schemes offer employees a stake in the business, encouraging loyalty and helping you to retain key staff. They also provide an incentive or reward for performance, and can help recruitment. See our guide on how to set up employee share schemes.

Issued capital
A company need not issue all its capital at once. Issued capital is the nominal - rather than actual - value of the part of the authorised share capital that has been issued to shareholders.

A company with an authorised capital of 1,000 shares at £1.00, which issues 500 shares, has an issued share capital of £500.

Public limited companies must have at least £50,000 of issued share capital. At least a quarter of this, plus any premium from selling the shares at a higher price, must be paid up before the company can start trading.

Any unissued shares can be issued later by the directors, subject to the rules set out in the Articles of Association, but typically through an ordinary resolution. The company sets the price of these shares.

Types of shares

A company may have many different types of shares that come with different conditions and rights.

There are four main types of shares:

• Ordinary shares are standard shares with no special rights or restrictions. They have the potential to give the highest financial gains, but have the highest risk. Ordinary shareholders are the last to be paid if the company is wound up.
• Preference shares typically carry a right that gives the holder preferential treatment when annual dividends are distributed to shareholders. Shares in this category have a fixed value, which means that a shareholder would not benefit from an increase in the business' profits. However, usually they have rights to their dividend ahead of ordinary shareholders if the business is in trouble. Also, where a business is wound up, they are likely to be repaid the par or nominal value of shares ahead of ordinary shareholders.
• Cumulative preference shares give holders the right that, if a dividend cannot be paid one year, it will be carried forward to successive years. Dividends on cumulative preferred shares must be paid, despite the earning levels of the business.
• Redeemable shares come with an agreement that the company can buy them back at a future date - this can be at a fixed date or at the choice of the business. A company cannot issue only redeemable shares.
  

Sale and transfer of shares

Share dealing is a complex area and specialist advice should be gained from solicitors, accountants and company law agencies.

Transfer and transmission of shares
Shares in a listed company are transferred through brokers using the Stock Exchange CREST network service. However, in a private or unlimited company, shares are usually transferred by private agreement between the seller and buyer, subject to the company's rules and approval of the directors.

Certain taxes apply when you transfer or sell shares. Stamp duty is normally payable when you transfer shares.

Also, any gains you've made on selling shares may be subject to Capital Gains Tax.

You should be aware that shares must be transmitted by law when a shareholder dies or becomes bankrupt. If this occurs, the shares and the rights associated with them are given to a personal representative or executor.

Issuing a prospectus
If you want to list your company on the Stock Exchange or offer unlisted securities to the public, you need to publish a prospectus or listing particulars. Only a public limited company can do this.

The prospectus has three main functions:

• it sets out all the information that you must make public under the Listing Rules
• it acts as a marketing tool for shares in your company by describing the business and its prospects
• it sets out the price of your company's shares and how much capital you hope to raise

A copy of this must be sent to the Registrar at Companies House. The UK Listing Authority, part of the Financial Services Authority, must also approve the prospectus.

Paying dividends and paying tax

At the end of a calendar year, a company's board decides whether the business has done well enough to pay shareholders a dividend. A dividend is a part of the company's profits that is given to shareholders. In larger companies, it is common for an interim dividend to be paid at the half-year point. The dividend is calculated per share, so the more shares you own the more money you get. Dividends attract income tax, but not National Insurance.

Many company share schemes allow employee shareholders to reinvest dividends in further shares called dividend shares. A maximum of £1,500 in dividends can be reinvested in this way each year. If an employee holds these shares for three years, they pay no income tax on them. If not, the dividend used to pay for the shares becomes taxable.

When paying dividends, the company must send a dividend voucher to the shareholder by post. This shows the amount of the dividend and the amount of tax credit. The tax credit shows the amount of tax paid by the company on the shareholder's behalf. Dividends are paid after tax has been deducted at the basic rate. If you pay a higher rate of tax, you may be liable to pay additional tax on your dividend.

Companies can pay dividends electronically if a shareholder agrees to it. Companies no longer need to send a dividend voucher in such cases.

Making changes to share capital

As business needs change, directors of limited companies have a number of options with which to control share capital and shares. One option is to issue more shares and increase authorised share capital or cancel unissued shares in order to decrease authorised share capital.

If the business is expanding, the directors may issue more shares to new shareholders to attract cash investment. If appropriate, shares can also be consolidated or subdivided. Directors of limited companies have legal obligations in these areas and Companies House must be informed.

Increase or decrease of authorised share capital
A company can increase its authorised share capital by:

• passing an ordinary resolution - unless the Articles of Association require a special or extraordinary resolution
• sending a copy of the resolution, and the completed form 123, to Companies House

A company can decrease its authorised share capital by:

• passing an ordinary resolution to cancel unissued shares
• sending a completed form 122 and the resolution to Companies House

You can order forms online from the Companies House website.

Issuing shares to a new shareholder
A company can issue shares to a new shareholder by passing a directors' resolution, then completing and returning form 88(2) to Companies House within a month of the first allotment of new shares.

You can download form 88(2) to inform Companies House of newly allotted shares from the Companies House website (PDF) - or you can complete form 88(2) online when you register with the Companies House WebFiling service.

Note that the directors must be authorised to allot shares. The authority can be in the articles or given by an ordinary or elective resolution.

Changing the shares
A company can consolidate or subdivide shares if authorised to do so by the articles. Consolidation is when the shares are put together and then divided into shares of larger amounts, eg 200 shares of £1.00 are consolidated to create 100 shares of £2.00. Subdivision is when shares are divided into smaller amounts.

To consolidate or subdivide shares a company must pass an ordinary resolution, then send the resolution and a completed form 122 to Companies House within a month of the change.