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Why do companies give employees shares?
According to HMRC, in the tax year ending 2021,...
As the name suggests, ordinary shares are the most common kind of equity limited companies dish out. But as you'll discover, it's not always the optimal choice.
Last updated: 21 November 2023.
There are all kinds of shares you can issue, though ordinary shares are usually the first kind to spring to mind. We’ve written this guide to make sure you fully understand those alternatives so you can make the right choice for your business.
Read on for an overview of what ordinary shares are, their advantages and disadvantages, and the other kinds of equity you might want to consider offering your employees and investors instead.
Every limited company in the UK is split into a certain number of shares. Ordinary shares, also known as common shares, are what many of those companies are founded with and choose to issue.
Ordinary shares generally have the same rights to capital, dividends and voting rights - but not always.
Equal rights to capital, yes. But ordinary shares can be voting or non-voting, dividend or non-dividend bearing. It all comes down to the share class (we’ll come onto that later).
When you give someone ordinary shares in your business, you’re giving them ownership of a fraction of your company. So, someone who owns 100 shares in a business with 1,000 total shares owns 10% of that company.
And they’d get a share of the profits if your company is acquired or has an Initial Public Offering (IPO) and joins the stock exchange as a listed company.
That ownership can come with voting rights. If that’s the case, then that person’s vote has a significant sway in company meetings and they’d receive a tenth of the profits when the company’s shares become valuable.
Here are five fundamental things you need to know about ordinary shares:
As we said, you can have different types of shares, like ordinary shares. But within this share type, you may come across various ‘classes’, like Ordinary A, Ordinary B, etc.
Each tends to be ever so slightly different in terms of the rights and privileges they carry - like voting rights or the rights to dividends. Speaking of…
That gives your ordinary shareholders the ability to vote ‘yes’ or ‘no’ on major decisions you want to make to your company, such as whether to accept a takeover bid. If the majority of your shareholders vote against a change you want to make, then tough luck.
Which is a share of the profits the company has made that its directors share out (usually every three or six months).
However, owners of ordinary shares will only receive those dividends if your company is profitable and its directors choose to pay those profits to its shareholders rather than invest it back into the business. This means you’re far from guaranteed a slice of a company’s dividends if you only own ordinary shares.
IF the business is sold or has an IPO. So, if your company’s shares are worth £10 when your business is acquired, that shareholder will receive the full £10 they’re worth.
BUT only once people like preferred shareholders have received their slice of the pie. If there’s no money left over then investors holding ordinary shares won’t receive anything.
Ordinary shares have two main drawbacks: they're unconditional and not tax-friendly.
Giving someone ordinary shares can sometimes be risky. What if they let you down? Even so, if they have ordinary shares they could walk away with a slice of the pie, which doesn’t feel fair, right?
So what’s a business owner to do? It makes total sense to get people invested in your company’s success and reward them for their efforts. Thankfully, there are alternatives worth considering that yield the same (if not better) results.
For example, give an employee conditional shares in your company and they need to hit certain milestones until they receive their slice of the pie.
Ordinary shares often bear a heavy tax liability. Ordinary shares are taxable as income if they are issued for less than the unrestricted market value (UMV). If the shares are worthless at the time of issue there is no tax, if the UMV or above is paid there is no tax but if less than the UMV is paid, income tax is due on the difference.
Ordinary shares are the most common type of shares companies grant to employees and investors. But we’d argue they’re not the best fit for most businesses, not in every circumstance.
Here’s a look at the other alternatives available to you – and which might be the best choice for your business.
Preference shares – known as “prefs” – can guarantee their owners a set amount of dividends from a company each year. They can also entitle them to a specific amount of capital if a company is wound up, meaning they’re not left empty-handed if a company goes under.
Ordinary shares typically have equal rights to capital, whereas preference shares have preferential rights to capital.
Investors often prefer preferred shares because they provide a guaranteed slice of the pie when a company shares out dividends. Plus, they’re a safer bet, since they’ll pay out first if the company does have difficulties.
A business’s existing ordinary shareholders might also be happy that you offer preferred shares to new investors, too.
While this may mean new shareholders get a better share of dividends or capital than them, it may also mean that there is a better chance your existing ordinary shareholders will see a return on the equity they have in your company, as otherwise this investment might not have been achieved, and the overall business expansion may have suffered.
Ordinary shares are simple to set up and manage. And that makes them an attractive option for business owners who have a million other things to worry about alongside setting up a share scheme.
But they can be risky.
What if you give ordinary shares to a new employee who then doesn’t deliver as promised? Once you’ve handed those shares out you can’t ask for them back.
And that’s where conditional shares come in.
When you give someone ordinary shares in your company, they own them straight away. conditional shares, on the other hand, don’t become theirs until specific conditions that you’ve set are matched.
If a recipient of your conditional shares fails to hit the milestones you’ve set out they won’t receive their cut of your business. This protects you from giving equity to people who ultimately don’t deliver on their promises.
Conditions can be:
You can set whatever conditions you think will best incentivise your employees to do their best work (and you’ll find plenty of examples in our free Conditional Equity Milestones guide).
Conditional shares make a lot more sense for most businesses than ordinary shares. They protect you from giving away precious equity in your business to people who end up not repaying your faith in them.
They also act as the perfect incentive to get people to do their best to help grow your business so they truly earn their slice of the pie.
Grant someone ordinary shares in your business and they’ll receive their full value when your company is sold - even the value they didn’t help create.
Growth shares – which are actually a special class of ordinary shares – allow you to reward people for the part they play in growing your business, but not the value that was created before they joined (or started working with) your company.
Your growth shares aren’t worth anything until the value of your company’s shares rises above the hurdle rate. Plus, you can set conditions recipients need to hit before they can realise the value of their growth shares too.
This makes growth shares a much better way to incentivise employees, contractors, and advisors than ordinary shares. And they’re just as easy to set up as ordinary shares through Vestd.
There’s nothing wrong with ordinary shares. They’re one way to keep things simple. After all, things are easy to keep track of when everyone has equal rights to capital.
Ordinary shares are, well, ordinary.
Not to mention, a little risky (in some cases) and less attractive to investors than preference shares.
We’ve designed Vestd to make sure all three alternatives to ordinary shares are easy to set up, manage, and keep track of.
The platform can handle EMI options, growth shares, and unapproved options - all of which can be conditional. Conditional growth shares by the way are the beating heart of our super smart Agile Partnerships framework.
But if you do want to issue ordinary shares, you can easily do that too!
If you want to chat about what the best option for your business is, book a call with an equity specialist today. They’ll help you decide which kind of shares will work best for your business and give you a tour of the platform too.
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According to HMRC, in the tax year ending 2021,...
When people think of shares, they usually think...