The money that your business can raise as debt will generally be limited by the assets available to give as security. Any money that your business needs in order to trade or invest for the long term into the business, which cannot be raised as debt or grants, will have to be invested into it by either introducing capital (which is to say money) from outside (in shares in a company) or later by leaving profits in the business. It is this owner’s cash that is referred to as equity. A provider of equity is putting money into the business normally in return for a share in both its ownership and its profits and future value.
An equity provider is therefore in a fundamentally different position from a normal lender when it comes to risk and return: As a result, if you seek other equity investors for your business (such as backing from a VC firm), you will be selling part of the ownership of your business to these investors, and as a result reducing (diluting) your own percentage holding in the business and, in the process, your control over it as well as your share of its present and future value. Other than in respect of capital raised by you from your own resources to put into your own business as a sole trader or partner in a partnership, this type of funding is really only applicable to limited liability companies through the issue of shares. This chapter therefore covers:
Shares And Dividends
SharesFor most small businesses in their earliest days of trading, shares simply reflect the ownership of the company and have nothing to do with raising finance as they tend not to be tied to any particular sum or investment.
The number and value of the shares that your company is allowed to have (known as its authorised capital) and how this is to be divided up into individual shares will be set out in the company’s memorandum of association, which is a key part of the company’s constitution. Most off-the-shelf companies will, for
example, be incorporated with 100 £1 ordinary shares giving a total authorised capital of £100.
However, not all of the shares need to be issued at once. At the founding of the company the organisers will arrange for some of these shares to be issued to the initial shareholders (who are known as subscribers for the shares) and who therefore become shareholders or members of the company. Again typically in an off-the-shelf company this will be two £1 shares, giving the company an issued share capital of £2.
The company should in turn have received payment of £2 from the shareholders for their shares so that the shares are paid up. If cash has not been paid for shares that have been issued then, in the event that the company fails, those shareholders who have not paid up the value of their shares can be called on to do so.
Should you then wish to buy this off-the-shelf company, the subscribing members will complete stock transfer forms signing their shares, and therefore the ownership of the company, over to you. Since you will now own both of the only shares issued, you will own 100% of the company (as you own 100% of its issued share capital), despite the fact that 98% of its authorised share capital has yet to be issued.
So long as they are authorised to do so by either the company’s constitution or by resolution passed by the shareholders, the directors of the company can then go on later to issue (allot) the remaining shares subject to the rules set out in the company’s articles of association, which is the other key document of its constitution. The shares might be issued for the payment of their
nominal face value of £1 each (at par) or the company might set a price which includes a premium so that, for example, a new investor might be required to pay the company say £500 for each share they received, which would mean that the company received £1 for the share and a £499 share premium into its reserves.