A fundamental business necessity – for both start-ups and long-established companies, big or small – is having an effective way to obtain adequate funding whenever needed for operations and growth.
Aside from obtaining a loan from a financial institution or other willing lender (debt capital), a frequently used method of achieving a capital injection or investment is by way of issuing shares / equity.
The focus here is on the latter, and on ordinary shares in particular. We will be addressing preference shares and its various features and requirements in a separate article. In the meantime, this article takes a look at the various classes of ordinary shares that could be issued to raise capital, some notable procedures and requirements from the Companies Act 2016 (“the Act”), and some key legal documents involved in the process.
Rights issue vs bonus issue
A bonus issue is when new shares are issued but the shareholders do not make any payment because the cost is absorbed by the company through a capitalisation of some of the company’s reserves or profits. While this results in an increase of shares in circulation, it does not involve any new capital injection to the company.
Therefore, where a company’s objective is to raise capital, it will be looking at issuing shares under a rights issue – i.e. where existing shareholders are entitled to subscribe to new shares in the company in direct proportion to their existing shareholding in the company, or sell their rights to take up the offer to participate in part or in full to new shareholders.
Different classes of ordinary shares
Various types / classes of shares are categorised based on the rights attaching to those shares.
As mentioned, we will be discussing ‘preference shares’ separately, so the point to note here is that, among ‘ordinary shares’, there can also be various classes.
While there is no precise definition of ‘ordinary shares’ in the Act, these are generally shares which gives the shareholder a right to attend, participate and speak at a member’s meeting, a right to vote on shareholders’ resolutions, and to participate equally in any dividends or surplus profits/assets (after preference shareholders are paid).
In accordance with section 69 of the Act, a company is entitled, subject to its constitution, to issue shares in different classes, i.e. to issue shares with non-identical rights attached. For example, a company could choose to issue a combination of one vote, multiple votes or no votes per share.
Different classes of ordinary shares could also be distinguished based on other features such as the right to receive dividends. On this point, section 89(2) of the Act clarifies that subject to the constitution of the company, rights attached to shares are not to be regarded as different from those attached to other shares in the same class only because they do not carry the same rights to dividends in the twelve months immediately following allotment.
Note that section 90 of the Act requires a company that has different classes of shares to state the following prominently in its constitution:
- that the company’s share capital is divided into different classes; and
- the voting rights attached to shares in each class.
Further, if a company has a class of ordinary shareholders who are not entitled to vote at general meetings of the company, the descriptive title of such class needs to include the words ‘non-voting’ and such description needs to appear legibly on any share certificate, prospectus or directors’ report issued by the company.
Default pre-emptive rights for existing shareholders
Where new shares are to be issued by a company which rank equally to existing shares as to voting or distribution rights, section 85 of the Act provides as a default, pre-emption rights to holders of existing shares such that those new shares must first be offered to the holders of the existing shares in a way which would (if the offer was accepted) maintain the relative voting and distribution rights of those existing shareholders; unless the Company’s constitution states otherwise. As such, if for example, a start-up wishes to issue new ordinary shares to VC investors without first giving the existing founders/ordinary shareholders a pre-emptive right to subscribe for the new shares, the company’s constitution would need to be amended to allow for this approach or procure the waiver of such default pre-emption rights.
Additionally, in the context of raising new capital from shareholders / investors, the Act requires the directors of a company to obtain prior shareholders’ approval by way of resolution before exercising any power to allot shares in the company (including under an agreement or option or offer), unless the allotment of shares is made to existing shareholders of the company in proportion to the shareholders’ shareholdings. Any issue of shares made in contravention of the Act will be considered void at law, while any director who contravenes this section commits an offence and is liable to compensate the company and persons to whom the shares were issued for losses suffered.
It is therefore prudent for directors or founders to consult with the company secretary or legal advisor before undertaking any share issuance.
The following are some key legal documents (separate from the corporate secretarial documents) which are typically used in the process of raising capital through issuing equity/shares:
- Term sheet – this document sets out the key basic terms and conditions under which an investment will be made by a new investor.
- Subscription agreement – this agreement will be entered into typically for issuances of shares by the issuing company to non-existing shareholders / new investors documenting the terms of the subscription.
- Shareholders agreement – this agreement will set out the terms of the ongoing relationship between the shareholders of the company post-subscription. In some instances, it is also possible to combine the subscription agreement and shareholders’ agreement.
- Constitution – while it is generally optional for private companies to have a constitution, a share issuance exercise, in certain cases, could trigger a legal requirement for the adoption or an amendment of the company’s constitution.