Alphabet shares can be an attractive option for SMEs looking to tailor their ownership structure to meet diverse shareholder needs. They allow companies to tailor dividends to the financial and personal circumstances of each shareholder, potentially optimising tax efficiency.
However, the benefits of alphabet shares must be weighed against the complexity and potential risks they introduce. It’s crucial to ensure that the set-up is legally sound and in line with HMRC regulations to avoid unintended tax liabilities or disputes.
What are alphabet shares?
Alphabet shares can be an effective tool for dividend distribution. Under company law, dividends must be paid in proportion to shareholdings. The creation of an alphabet share structure overcomes this restriction by creating different classes of shares in a company, typically labelled as A, B, C.
Unlike ordinary shares, which usually offer the same voting rights and dividends, alphabet shares can be customised to provide varying rights and privileges to shareholders.
What are some of the benefits of alphabet shares?
- Alphabet shares allow companies to distribute dividends differently among shareholders. This can be particularly useful for family-owned businesses or companies with different classes of investors.
- Shareholders with different classes of shares can have varying levels of control over the company, allowing founders or key stakeholders to retain decision-making power while still raising capital.
- In a family company scenario, alphabet shares can be used to make use of the dividend allowances of family members who do not work for the company, but who do not have any other dividend income. This was more attractive prior to the reduction to dividend allowances, but still allows for tax savings.
What are some of the challenges relating to alphabet shares?
- The creation and management of multiple share classes can add complexity to the company’s governance and accounting practices.
- Different rights and dividends for shareholders can lead to disagreements, especially if not properly managed or communicated.
- While alphabet shares can be beneficial, they also come with potential legal and tax implications, particularly around dividend distributions and voting rights. It’s essential to navigate these carefully with professional advice.
- Alphabet shares can attract attention from HMRC who may choose to scrutinise the set-up, particularly if it appears that the alphabet shares were created primarily to reduce tax liabilities rather than for legitimate business reasons. This could lead to tax challenges or unexpected liabilities for the company or shareholders.
Alphabet shares: a working example
Consider a growing owner managed business owned by a single shareholder. There are key employees who contribute to the growth and profitability of the company. To adapt to the changes in the management team, the company might issue three classes of shares: A, B, and C.
- Class A Ordinary shares: The owner retains 60% of the shares (as class A) and the remainder are divided into B and C shares as follows:
- Class B shares are distributed to Board members who are strategic in the business and carry variable dividend payouts with voting rights.
- Class C shares are distributed to senior management who play a high level operational role in the business. Class C shares offer higher dividends and no voting rights.
This set-up allows the key employees to balance control and profit distribution according to their involvement and preferences. Plus, they can benefit from dividends immediately, as opposed to an EMI scheme.
However, this is only agreeable where the owners feel that the distribution is fair. Over time, differences in dividend payouts could lead to tension. Maintaining balance and fairness of the share classes becomes even more difficult as the business grows and new strategic management employees or investors come into play.
If the business does attract an investor or is acquired by a larger group, this particular structure can be beneficial to the main stakeholders working in the business. The shareholders could retain their shares, or they could sell their shares and distributions could qualify for Business Asset Disposal Relief (BADR), a tax relief that can reduce the amount of capital gains tax paid when individuals or certain trustees sell qualifying business assets.
The scenario can also be used for family-owned businesses where the parents and siblings are shareholders in the business and distributions are varied based on involvement.
How can we help?
Alphabet shares offer significant flexibility and can be a powerful tool for SMEs looking to tailor ownership and dividend distribution. However, their complexity requires careful consideration and professional guidance.
If you’re considering implementing alphabet shares in your company, it’s advisable to consult with an accountant or legal professional to ensure the structure aligns with your business goals and complies with all relevant regulations. To discuss your particular circumstance in more detail, email tax@haroldsharp.co.uk or call 0161 905 1616.