An introduction to shares: Reducing share capital

Welcome to the fifth and final article in our mini-series covering the basics of shares.

In this longer article, we’ll be looking at the more complex topic of reducing share capital either by way of:

• A capital reduction.
• A buy-back of shares.
• A redemption of shares. 

Before reading this article, it may be useful to refer to our earlier articles for a full overview of share capital.

As before, the focus in these articles is on UK private companies limited by shares.

Reducing share capital – The why 

We’ll look at two options here:

Reasons for a capital reduction

A capital reduction – a process whereby shares (or distributable reserves) are cancelled – may be carried out to:

• Return surplus capital: If a company has surplus cash or assets (for example, if it has raised funds for a project that didn’t go ahead as planned) it may look to transfer it directly to shareholders by re-paying and cancelling shares issued.
• To return surplus capital back to shareholders when going through a de-merger or to reduce or to simplify any complex share structures that are no longer required.
• Creating or increasing distributable reserves or reducing accumulated losses: A company can find itself in the position where it is blocked from paying dividends to shareholders – even if it is trading profitably. A reduction of capital can be used to eliminate losses and/or increase distributable reserves, enabling the payment of dividends.
• To facilitate a share buy-back or redemption: A company wishing to buy-back or redeem shares out of distributable reserves may need to carry out a reduction of capital to firstly create or increase available distributable reserves.

Reasons for a share buyback or share redemption

Reasons why a company would want to carry out a buyback (or redemption) include:

• To exit a shareholder from the company: The most common use for a buyback (or redemption) is to allow for the purchase of a departing shareholder’s shares (perhaps because the continuing shareholders are unwilling or unable to fund the exit themselves). The process allows the continuing shareholders to maintain control of the company in the same proportions that they have without risking the exiting shareholder’s shares being offered to a third party.
• To return cash to shareholders: Companies that hold large amounts of cash whether from accruing retained profits or following the proceeds of sale from the disposal of an asset may want to divest some of it by returning funds to shareholders.
• As part of the operation of an employee incentive scheme: A company that operates an employee share scheme may wish to facilitate the purchase by the company of an employee’s shares when they leave employment.
• To adjust the proportions in which shareholders hold shares: Some shareholders may wish to realise part or all of their investment in shares while other shareholders may wish to increase their proportionate shareholding.

Reducing capital – The How

Carrying out a capital reduction

We’ll look at two alternative options here, focusing on the simpler Solvency Statement method:

Solvency statement-the solvency statement procedure (available only to private limited companies) is the simplest option. It allows the company to reduce share capital and certain other reserves. To use this method:

• The articles should be checked to ensure that it the reduction is not prohibited or restricted.
• The directors should approve the reduction and record their decision in a resolution or board minutes.
• A statement should be signed by all of the directors stating that the company is solvent. It should be noted that:
  • It is an offence to make this statement without having reasonable grounds to believe it is true.
  • Usually directors will wish to review the last statutory accounts, most recent management accounts and any material changes since the date of the last management accounts. They should consider any upcoming liabilities and cash flow and may also consider seeking an opinion from the company’s auditors.
  • If the directors intend to wind up the company within a year, then they will confirm in the solvency statement that the company will be able to pay its debts within 12 months of the date that the winding up procedure starts.
• A special resolution (requiring the approval of shareholders representing at least 75%+ of shares) should be passed approving the capital reduction.
• The following documents must be filed at Companies House within 15 days of the resolution being passed:
  1. The solvency statement.
  2. The special resolution.
  3. A statement of compliance by the directors.
  4. If shares are being cancelled (but not if reserves are being reduced) a statement of capital – form SH19 (with the Companies House filing fee £33, or £136 express service).
• The strict timeframe should be noted and that the reduction in capital only takes effect once it is registered at Companies House.

Court approved procedure – this lesser-used method involves a special resolution of the company’s shareholders and an application to and confirmation by the court.

The court will only approve a reduction of capital if the company’s creditors’ interests will not be damaged so it may involve advertising the proposed reduction or obtaining the consent of all creditors.

Carrying out a share redemption

It should be noted that:

• Only shares which have been issued as redeemable shares can be redeemed – usually at the option of either the shareholder or the directors.
• The redemption terms are usually set when the shares are issued.
• Non-redeemable shares cannot be converted into redeemable shares and a company cannot have only redeemable shares in issue.
• Once redeemed, redeemable shares are always cancelled.
• Payment can be deferred – as long as the terms of the redemption are being followed.

Generally, a redemption is financed out of available profits (or from the proceeds of a new share issue) and no shareholder consent is required.

To redeem shares:

• The directors should approve the redemption and record their decision in a resolution or board minutes.
• A form SH02 should be filed at Companies House.

Carrying out a buy-back

it should be noted that:

• A share buy-back is generally financed out of distributable profits (or using the proceeds of a new share issue).
• Shares can be purchased without the necessary distributable reserves up to the lower amount of £15,000 of 5% of the company’s share capital each year. This is sometimes known as the ‘de minimus’ rule. Other purchases from capital (I.e. not from distributable profits) above this level are possible but are complex. Buy-backs out of capital are not covered in this article.
• As previously noted, a capital reduction may be used in advance of a buy-back to create the necessary distributable reserves.
• Payment on a buy-back of shares must be made in cash and cannot be deferred or paid in instalments.
• Following a buy-back, in most circumstances, the shares are cancelled – although it is possible for the company to hold them in treasury for future use.

In order to carry out a share buy-back out of reserves:

• The articles should be checked to ensure they do not prohibit a buy-back.
• Management accounts dated within three months of the date of the buy-back should be prepared to show that there are sufficient distributable profits available to fund the buy-back.
• The directors should approve the buy-back and record their decision in a resolution or board minutes.
• A buyback contract should entered into between the company and the shareholder involved.
• An ordinary resolution needs to be passed to approve the contract (approved by shareholders holding more than 50% of the voting shares and not including the shareholder whose shares are being bought back).
• If the consideration being paid for the bought-back shares is more than £1,000, stamp duty will need to be paid (at a rate of 0.5% of the consideration, rounded up to the nearest £5). An SH03 form will need to be prepared and submitted to the HMRC Stamp Office for adjudication.
• The form SH03 (together with the Stamp Office confirmation, if applicable) and a form SH06 (if the bought back shares are being cancelled) should be filed at Companies House.

Comparing a share capital reduction with a share buy-back

• The rules relating to capital reductions allow greater flexibility.
• The ability to reduce capital extends beyond issued share capital to statutory capital reserves (share premium account, capital redemption reserve or redenomination reserve).
• Funding a buy-back of shares must be made from available profits. A company opting for a capital reduction can therefore ensure that its distributable reserves are preserved for the purpose of paying dividends in the future.
• Stamp duty (at a rate of 0.5% on the consideration paid) is payable on any share buyback over £1,000, but not a capital reduction.
• A buyback may be appropriate where the company wishes to stagger the acquisition of its shares or exit just one shareholder.
• A capital reduction can also be undertaken where shares are cancelled for zero consideration.

How Gerald Edelman can help

Whilst we hope that this article provides a useful summary, we know that every company is different.  

If you wish to discuss the shares in your company, please contact us today.  

Last updated: 20.12.2024