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Reducing your company’s share capital is a challenging process with substantial hurdles. Reducing share capital can serve several strategic purposes. For instance, it can improve a company’s financial flexibility by creating distributable reserves, allowing directors to authorise higher dividend payments. Additionally, it can return surplus capital to shareholders or clean up the balance sheet by eliminating outdated figures, giving a more accurate representation of the company’s financial health. Moreover, share capital reduction can facilitate the buyback of shares or redemption of redeemable shares, enhancing shareholder value and improving the company’s capital structure. This article will give you an overview of the circumstances under which the law permits you to reduce your share capital and provide a summary of the procedural steps directors must follow.
Why Would a Company Reduce its Share Capital?
Companies reduce their share capital for a variety of reasons, including to:
- create distributable reserves so directors can authorise paying more in dividends;
- redistribute capital back to its shareholders;
- rebalance the company’s balance sheet so that the equity figure more accurately represents the assets owned;
- redeem outstanding redeemable shares or buy back ordinary shares; and
- facilitate a disposal of the company (or a portion of it) through a business sale.
Methods for Reducing Share Capital
A private company can either reduce its share capital:
- via the directors issuing a solvency statement; or
- through a court order.
In both cases, the shareholders must approve the measure via a special resolution at a shareholder meeting or written resolution. A special resolution requires 75% or more of the votes cast to succeed.
In practice, small companies are unlikely to seek a court’s approval. Instead, the companies’ shareholders authorise the measure via special resolution. The directors then issue a solvency statement.
We will now examine the two processes. Notably, the solvency statement route is more common than seeking a court order.
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Solvency Statement
For a private company to reduce its share capital via the solvency statement route, the company’s articles must not restrict this ability.
Additionally, the reduction cannot result in the company having any issued share capital. Nor can the reduction result in only a single shareholder holding all the shares.
Provided your company meets these conditions and shareholders vote in favour via a special resolution, directors should then issue a statement of solvency. This statement assures creditors that the company has sufficient funds to continue as a going concern. Unlike other alterations to the company’s share capital, the directors do not have to obtain an audit of its accounts.
However, when directors issue a solvency statement, creditors and other stakeholders can challenge the legitimacy of the solvency statement after the fact. This can result in the directors assuming substantial liability.
Court Sanction
As a director, you must take the following steps if you wish to initiate a share capital reduction via court sanction:
- Consult with your company’s articles to ensure that it does not restrict the ability of directors to reduce the share capital.
- Determine:
- when you will present the petition to the court;
- the date you will convene a director’s hearing; and
- the date of the petition hearing.
- Have shareholders approve the measure via special resolution.
- Present the petition to the court.
The court will review the merits of the petition, considering the interests of the creditors. If this threatens their interests, the court can (and likely will) reject the hearing. Additionally, an official from Companies House will witness the hearings and, if approved, reduce the share capital in court. You must then convene with Companies House to supply certain documents.
Practical Considerations
If your company intends to reduce its share capital to free up the amount of money it can distribute to its shareholders, there are certain tax considerations to note. In general, the law treats the newly-created reserve as realised profit which can attract corporation tax liability.
If a company seeks a court’s approval, the court has the power to treat the reserves as other than realised profits.
Key Takeaways
Ordinarily, a company can reduce its share capital only through two mechanisms. The most common is where the directors issue a solvency statement. The other option is to seek the court’s approval. In both cases, the shareholders must approve the measure to reduce the company’s share capital via an ordinary resolution.
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Frequently Asked Questions
A company can reduce its share capital through two mechanisms. First, company directors can issue a solvency statement. Alternatively, you can seek the court’s approval. In both cases, the shareholders must approve the measure to reduce the company’s share capital via an ordinary resolution.
Companies reduce their share capital for various reasons, like creating distributable reserves so that the directors can authorise paying more in dividends or redistributing capital back to its shareholders. Reducing share capital is also helpful in rebalancing the company’s balance sheet so that the equity figure more accurately represents the assets owned.
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