As your business grows, its financial needs change, finding the need to adapt share capital structures to meet evolving needs and opportunities. Understanding when and how to alter share capital; whether through increases, decreases, splits, or consolidations, is crucial for SMEs to optimize their financial strategies and operational agility.
Share capital is money paid by shareholders to gain equity in a company or the money raised in exchange of interest in a company. The money usually stays with the company until its liquidation. The share capital cannot be withdrawn and cannot be used as collateral for a loan, however, it is transferable in the event that a shareholder may want to exit the company. In Kenya, the Company Act, 2015 and Insolvency Act, 2015 anchor the alteration of shares in a Company.
TYPES OF SHARES
Before delving into the intricacies of share capital alterations, it is essential to grasp the diverse types of shares available. Each type serves a unique purpose tailored to different investor preferences and company goals, shaping the company's trajectory and relationships with stakeholders.
- Ordinary Shares - also known as equity securities, these have voting, dividend, residual and capital rights to them. In this case, shareholders receive notice of the meetings to attend where they can vote which includes electing the board of directors, approving significant decisions, and voting on other matters that require shareholder approval. Ordinary shareholders also receive less dividends compared to shareholders who hold preference shares. Normally, these are the shares traded in the stock market;
- Preference Shares - often, these have no voting rights but rather, a preferential right to receive a fixed percentage of dividends and capital distributions before other shareholders. An advantage of these kinds of shares is the return of capital when the company goes into liquidation. Investors are likely to go for this type of shareholding if receiving a fixed dividend payment is a priority over ownership and voting rights. These are most advantageous when dealing with income investors, risk-averse investors, long-term investors, companies in need of capital, venture capital and private equity;
- Redeemable Shares - the company issues these shares with the possibility or intention to buy the back at a later date out of the accumulated profits or the process of a fresh issue of shares. This allows for the repayment of the principal share capital to shareholders. The company may redeem these shares at an agreed value on a specified date or at the discretion of the directors on the condition that the company is a going concern. Investors and companies interested in flexibility in managing capital and shareholder structure go for this type of shares. It is advisable when there are temporary capital needs, investors seeking liquidity, risk management, employee stock ownership plans;
- Convertible Preference Shares - this is a hybrid of convertible and preference characters. These carry rights to a fixed dividend for a specified period, after which it can be decided if the shares will be turned back to ordinary shares or remain the same, the conversion rate being jotted down in the company’s constitution. This is meant to allow a shareholder to buy ordinary rates at a lower price. This is suitable for income-oriented investors as it is used to raise capital without watering down the ownership and voting rights.
Shares can then be grouped into different categories and labelled by letters to identify the variation in percentage of each holder. For example Class ‘A’ shares and Class ‘B’ shares, where the former are issued to the general public and have voting, dividend, residual and capital rights while the latter may have preferential rights and other privileges.
ALTERATION OF SHARE CAPITAL
To alter share capital, the shareholders must pass a special resolution as provided in section 68, which must be passed by at least 75% of the votes cast by those entitled to vote in person or by proxy. Alteration of share capital can be done through increasing, reducing, splitting or consolidating shares.
1. Capital reduction
Supported by Section 407 of the Company Act, a company may need to reduce its share capital due to cancelling unpaid share capital, cancelling any paid-up share capital that is lost or unrepresented by available assets and/or repaying any paid-up share capital in excess of the company’s requirements and/or by ordinary resolution if the articles of association allow.
The procedures differ depending on whether the company is public or private in that for the former, it is required to apply for a court order through the High Court and the creditors of the Company are entitled to object to the reduction of the share capital. For the latter, the resolution for reduction of capital must be supported by a solvency statement. The Directors of the company are required to execute a statement of solvency of the company in accordance with Section 421 (1) of the Company Act, which must be within fourteen days after the resolution for reducing the share capital is passed.
2. Share split
Share split is where shares are subdivided into multiple shares of smaller nominal value. This also requires the approval of shareholders through a resolution. This process makes the shares more affordable but does not affect the rights accompanying the holding. An example of this is where a company with 1,000 shares valued at Ksh. 100 each can be split to have 2,000 shares of Ksh. 50 each; this can be termed as a 2-for-1 share split where the total market value of the company remains unchanged.
3. Consolidated shares
This is a combination of several shares resulting in the reduction of the number of shares but an increase in the nominal value. This as well must be passed by the shareholders through resolution. A company with 2,000 shares of Ksh. 50 each may be consolidated in 2-for-1 consolidation to then be 1,000 shares valued at Ksh. 100 each; the market value remaining unchanged.
4. Cancellation of shares
A company may cancel issued or unissued shares when forfeited or surrendered shares in a public company are not re-allotted within three years are required or in the instance of share buyback (purchase of own shares). This reduces the shares of the company but the circumstances surrounding share cancellation render it different from share reduction.
5. Share capital increase
Guided by Section 63 of the Act, companies can increase share capital necessitated by factors that are both internal and external such as debt reduction, expansion and growth as well as regulatory requirements. This incurs stamp duty at 1% on the additional share capital.
CONCLUSION
It is key to note that any alteration of a company’s shares must be accompanied by shareholders’ resolution as well as a notice to the registrar giving details of the reorganization. Companies ought to review their articles of association to determine whether they have the authority to alter share capital by ordinary resolution. If the articles do not provide such authorization, or if the alteration requires a different level of approval, such as a special resolution, then the company must follow the procedures outlined in its articles and the Company Act accordingly.
HOW WE CAN HELP
CM SME Club is well equipped with knowledge and experience in legal and regulatory compliance and we provide valuable legal advice and guide businesses on restructuring including changes in shares and shareholding and advising on the documentation required to protect the interests of the Company. Contact law@cmsmeclub.com for assistance.
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