Navigating the legal landscape around startup shares

Authorising and issuing new shares can be tricky. Fortunately we have some advice to help you find your feet

Navigating the legal landscape around startup shares

Without a doubt, being able to offer up equity in their business provides fast-growth startups the rocket fuel they need to scale. But no company has an unlimited number of shares at their disposal. This means that from time to time when entrepreneurs want to hook new investors they will need to authorise new ones. And from a legal perspective, there are a few things entrepreneurs need to consider when topping up their share pool.

While many founders may feel that they have a right to the shares of the company they’ve founded by default, in reality things aren’t quite this straightforward. “If entrepreneurs are issued shares right at the very beginning, then they need to remember to pay for them,” says Andy Moseby, corporate partner at Kemp Little, the technology and digital-media law firm. “This catches a few founders out.” Fortunately, entrepreneurs need only set a nominal share value for the fledgling company, meaning the total amount they have to invest may only be in the order of hundreds of pounds. And their contribution need not even be in cash. “They could get their shares by transferring some intellectual property, providing some services or contributing something else of value to the company,” he says.

Before too long, it’s likely a startup will be looking to inject some additional capital into the business. But trading equity isn’t as simple as the founders selling a bunch of their own shares to a new investor. “When shares are transferred, then the money gets paid to the person who held them,” says Moseby. “Actually what founders want to do is get money into the company.” Inevitably, this will require the creation of new shares and the dilution of the startup’s existing share pool. “If the founders hold, say, 100 shares, what typically happens is that you’d subdivide those shares into a large number, such as one million shares, but instead of them having a nominal value of £1, they’re worth £0.0001 a share,” he says.

However, this is easier said than done. Given that increasing the number of shares in a startup dilutes the value of existing shareholders’ equity, startups will need to secure approval beforehand. Perhaps the easiest way to do this is by enshrining the right to authorise a certain amount of new stock. “The constitutional documents can be changed when you set up the company to give the directors authority to allot shares up to a certain amount,” says Moseby. But if this isn’t outlined in a startup’s articles, it will need to seek direct permission by way of a resolution of shareholders. “Fortunately a startup only needs 50% shareholder consent to give its directors the authority to allot new shares,” he says.

For a fast-growing startup looking to raise rapidly and bring on key talent, this can still be quite a time-consuming process, which is why it’s worth thinking about the future and leaving yourself some runway. “You can authorise a large number of shares to be issued, which would take into account not only the ones that are going to be issued this round but also future rounds,” Moseby says. Despite this, as a startup scales, diluting its share pool just to ensure it has some spare equity in its back pocket may not go down that well with institutional investors. “They will probably want to make sure that you can only issue the amount they’ve approved because they’ll want to make sure they have some kind of control over their dilution,” he says.

Once a startup’s directors have the authority to do so, actually issuing the shares themselves is comparatively straightforward: all that’s required is a board meeting where the directors formally announce how many shares have been issued and to whom. “All that then needs to happen is that person’s details get written up in the company books,” says Moseby. “That’s the point where they’re officially deemed to have been issued the shares.” Despite this, it’s still standard practice to give investors and talent evidence that their shares have been issued – although this doesn’t necessarily need to be done using paper and snail mail. “You should issue them a share certificate but there isn’t any reason why you can’t do so electronically,” he says.

Just because a startup is officially deemed to have issued the shares doesn’t mean there aren’t a few last Is to dot and Ts to cross. “Firstly, you have to fill out the SH01 form telling Companies House that you’ve issued a number of shares,” Moseby says. Additionally, startups will need to outline who their shareholders are and how many shares each holds in their yearly confirmation statement, the spiritual successor to the annual return. Finally, they will also need to maintain a PSC register, not only listing all of the parties that own 25% or more of the business but also any parties that own 25% or more of its corporate shareholders. “It’s about making it clear to Companies House who actually exerts a significant influence over the company and that ownership is not hidden by offshore companies or trusts,” he says.

Keeping on top of this kind of paperwork is vital, even when entrepreneurs feel they’re being pulled in many directions at once. “We’re realists: having time and money to grow the business at the outset is probably the most important thing for founders, rather than looking at the legal niceties,” says Moseby. But making sure the company has kept accurate books will save a lot of time in the long run: Moseby just spent a year helping a client apply to the courts to get their books amended. “It’s far better to have these things sorted right from the very off,” he says.

Josh Russell
Josh Russell

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