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Share Capital is money invested in the company by shareholders and investors. In a Private Limited Company, the Share Capital will usually be put into the company by the owners. For a Public Limited Company, the Share Capital can also be made up of capital invested by members of the public.
The owners will likely also have invested in the company and may have shares that have preferred rights. This is to confer upon them greater value than ordinary shares, which have been bought by public investors. Usually, shares in a public limited company will be bought on a stock exchange for capital investment.
Shares in a private limited company will usually have been invested by shareholders when the company has been set up. Once the Share Capital has been invested, it belongs to the company and is there to act as a cushion, to soak up any debts or liabilities, should the need arise.
Public Limited Companies will often issue shares in the company for people to purchase so that they can raise money or capital to use for company activities and growth.
Share Capital is often also referred to as ‘Paid in Capital’ and it is important to make the distinction between Share Capital and equity which is generated by the business itself. Share Capital has been ‘paid in’ by shareholders and investors.
Now that we understand what Share Capital is, we need to look at why a company would want to reduce its share capital.
Usually, the main objective of a company is to grow and expand, so this would seem counter-intuitive to want to reduce capital. Also, the rule that a company must have a certain amount of share capital to pay off debts means that there are restrictions and procedures to follow if a company does want to reduce capital.
The following are reasons why a company might want to reduce share capital:
- Paying dividends – sometimes if a company has experienced some difficult trading conditions resulting in some accumulated losses on the balance sheet, this would make it impossible to pay dividends to shareholders. A solution to this is to reduce the number of shareholders by carrying out a reduction of capital. The net effect of this can allow a company to pay a dividend to the remaining shareholders.
- Payback Surplus Capital – if a company has surplus cash or assets, they may decide to cancel shares in return for cash or non-cash assets, such as property paid to shareholders.
- Reduction of liability – a company may simply want to operate more efficiently by reducing shares to a more manageable level. This effectively reduces liability.
- Structuring Mergers and Acquisitions or a de-merger – if a company is restructuring or wishing to carry out a de-merger, a reduction in capital will often be used as part of the transaction.
After a successful Capital Reduction, the company value will remain the same but there will simply be fewer shares issued.
How to carry out a reduction of capital
The Companies Act 2006, Chapter 10 is the piece of UK legislation that provides rules for the Reduction of Share Capital. Section 641 of Chapter 10, provides the rules for how a Private Limited Company can reduce its share capital. Section 650 of Chapter 10, provides rules for how a Public Limited Company can reduce its share capital if the reduction would bring the nominal value of a public company’s allotted share capital below the authorised minimum of £50,000.
There must be nothing in the Articles of Association to prevent a reduction in capital. Also, a capital reduction cannot be carried out if it would mean that no member of the company would hold any shares other than redeemable shares. Lastly, at least one non-redeemable share must be in issue after the reduction of capital has been carried out.
Private Limited Company – a private limited company may carry out a reduction of share capital by the following options:
a) by passing a special resolution accompanied by a solvency statement, or
b) by a special resolution confirmed by the court.
In both options, the special resolution can be passed at a company meeting with the directors' present, or the special resolution can be written and sent to the directors. In both instances, the directors must have witnessed the solvency statement. This is because they should make a reasoned, risk assessed decision on the special resolution, based on the current solvency of the company. If they are at a company meeting, then the statement should be there for them all to peruse, or if the directors are receiving the written copy of the special resolution then they should all have received a copy, either before or at the time that the written resolution has been sent to them.
The solvency statement, which should accompany the special resolution is a statement to say that all the directors have formed the opinion that the company can pay all of its debts, or that if there is the intention to wind the company up, that the company can pay all its debts within 12 months of the intention to wind the company up. In forming their opinion, the directors must take into account all liabilities, including contingent and prospective. The statement must be dated on the date when made and include the names of all directors.
All the directors are liable for the solvency statement, irrespective if one or more does not have reasonable grounds to form the opinions expressed within it. The solvency statement must have been made not more than 15 days before the date on which the resolution was passed. A statement by the directors confirming this, must accompany the documents which are delivered to the registrar.
Within 15 days from the date that the resolution to reduce capital is passed, the company must register the resolution, providing documents including; a copy of the solvency statement, a statement of share capital, the statement from the directors confirming the solvency statement was not made too early.
In option b), a company may apply to a court to enact a resolution passed by the company to reduce share capital. If the proposed reduction involves either: diminution of liability in respect of unpaid share capital, or the payment to a shareholder of any paid-up share capital, then the court can decide to enact section 646, which allows creditors to object to the reduction. The court will hear any valid objections and decide whether the company should have to pay debts owed to these creditors before an order will be granted.
The court may make an order confirming the reduction of capital on such terms and conditions as it thinks fit. In passing this order, the court must be satisfied that every creditor who has the option to object to the resolution, has consented, or his debt or claim has been discharged.
Where the court confirms the order, it may ask the company to publish reasons why it has requested a reduction of share capital and any other prudent information regarding the company that it seems appropriate. After the court has made the decision to approve the reduction, the order takes effect from the time that the court order and statement of reduced capital is registered. The statement of capital must now show full details of reduced shares and allocations.
The easiest of the two options for a private limited company is option (a). However, it may be preferable to let a court decide if there are circumstances where some creditors objections cannot be resolved or perhaps not all directors want to sign the solvency statement.
Public Limited Company – they do not have the same options as a private limited company, and the only option for a public company wanting to carry out a reduction is by a special resolution confirmed by the court. If the PLC reduced its allotted share capital under the £50,000 threshold then they need to follow rules under Section 650. The rules of Section 650 say that a registrar must not make an order for the reduction of capital in these circumstances unless either;
- the court directs it, or
- the company is re-registered as a private limited company.
The order will only be granted if these rules under 650 are met. The request must satisfy the court and the company must re-register as a private limited company due to minimum authorised capital rules for a public limited company. Section 651 provides an expedited process for re-registration as a private limited company.
Once a court has approved the change of company designation, the court will then consider the special resolution of the company and any objections to the reduction. When considering the resolution of the now private limited company, it will consider any objections, usually by creditors. The court must be satisfied that the reduction will not damage the interests of creditors.