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Share capital can mean different things in different contexts. Broadly speaking, it refers to ownership in a limited company. Each share reflects a portion of ownership in the company. All shares in existence in aggregate refer to the company’s share capital. This article will discuss the purpose and advantages of share capital.
What is Share Capital?
In the broader sense, share capital describes the value of a company’s equity and the number of shares the company has issued. This helps you determine the value of each share. In turn, this makes it easier for investors to determine how much they are willing to pay to purchase shares:
- in your company; or
- from existing shareholders.
Only companies have share capital. Accordingly, a sole trader and a partnership cannot have share capital. While partnerships often issue partnership shares, investors do not generally treat partnership shares as favourably as they do shares in a company.
1. Shareholders Enjoy Limited Liability
A company limited by shares means that ownership in the company is measured by the number of shares in that company relative to the entire shares in existence. The vast majority of companies in existence are companies limited by shares.
The reference to limited refers to the fact that the law limits each shareholder’s liability to the fully paid-up value of their shares. For instance, if you own 100,000 shares issued to you at £1 each, the extent of your liability for the company’s debt does not exceed £100,000. Sometimes, a company may issue these shares at a discount or not demand immediate payment. In this case, the company can usually demand payment at any point. If the company goes into insolvency, an insolvency practitioner can obligate all shareholders to pay the full value of their shares if they have not.
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2. Share Capital Facilitates Creditor Certainty
The law considers it necessary that a company’s creditors, including its trade suppliers, have some assurance that the company has sufficient assets. Otherwise, a company could rack up considerable liabilities relative to its asset value. This would place its creditors in a compromised position.
However, companies must make certain public disclosures. This includes the value of its share capital. A company’s share value is equal to the value of all the shares the company has issued (at their fully paid-up value).
The nature of the balance sheet means the equity figure always equals the net asset value. When the company starts trading, creditors can be confident the company has £1m in assets to meet its liabilities. This is one of the advantages of share capital: it provides creditors with a ready-made approximation of the company’s value.
3. Share Capital Can Help Raise More Capital
The nature of share capital means valuing an individual shareholder’s interest in the company is quite easy. You simply calculate the value of each individual’s shares and divide it by the value of the share capital. As a result, it is straightforward to raise additional equity financing. A prospective investor can calculate what portion of financing it will contribute to the company. The company can then determine the number of shares they should issue.
For instance, suppose your company has started trading. After a year, its net asset value has grown from £1m (the initial share capital value) to £1.5m. You approach a prospective investor to raise an additional £500,000. This amount would equal 25% of the total net asset value after the investment. Accordingly, a starting place for negotiations would be to issue the investor with shares equivalent to 25% of the total share capital.
On the other hand, banks are more keen to lend to companies compared to other business structures. This is because it is more straightforward to secure the loan on the company’s assets and the shares itself.
LegalVision’s Buying a Business: Guide to Negotiating Terms allows you to protect yourself by understanding which key terms to negotiate when buying a business.
Key Takeaways
There are many advantages to share capital. For one, the law makes it easier to approximate the value of the company’s assets based on the value of the share capital. Share capital also makes it easier to raise debt and equity financing.
If you need help maximising your share capital, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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