At the start of what is a new financial year for many companies you may be thinking of getting investment into your business. One way for a company to do this is to issue new shares, a process known as an ‘allotment’.  Before allotting new shares directors should ensure they have the requisite authority and that the allotment is carried out lawfully, otherwise they risk breaching their directors’ duties, committing a criminal offence under the Companies Act and opening themselves up to civil action

Is there a limit on the number of shares the company can issue?

Although the concept of an ‘authorised share capital’ was abolished by the Companies Act, for companies incorporated before 1 October 2009 it may still be relevant. Those companies had an authorised share capital in its memorandum of association. This was effectively imported into the company’s articles of association on that date and operates as a limit on the number of shares that the company can issue until that restriction is either removed by an ordinary resolution or the company adopts new articles which do not contain such a limit.

Do the directors have authority to allot shares?

If the company is a private limited company with one class of shares, the directors will have general authority to allot new shares of the same class as the existing shares, provided there is nothing in the company’s articles which restricts this authority. If the intended allotment does not fall within that automatic authority, the directors must be granted an appropriate authority either in the company’s articles or by the shareholders passing an ordinary resolution.

Is there a shareholders’ agreement?

A shareholders’ agreement may impose additional restrictions on an allotment including giving existing shareholders the right to prevent an allotment or grant them a right of first refusal (also known as a pre-emption right).  It may also require any new shareholders’ to become a party to the shareholders’ agreement.  It shouldn’t be assumed that the shareholders’ agreement can continue as is, it should be reviewed to ensure that it properly addresses any issues which arise as a result of the new shareholders, for example, the balance of voting power amongst shareholders and the board of directors.  If the incoming investment is substantial the new shareholder may insist on changes which reflect their shareholding.

Do the existing shareholders have a right of pre-emption?

Pre­emption rights require any new shares in the capital of the company to first be offered to the company’s existing shareholders on the same (or more favourable) terms. In addition to the shareholders’ agreement, existing shareholders may have pre­emption rights by virtue of the company’s articles or under the Companies Act. In either case, it is important to either disapply those pre­emption rights or ensure that the company’s shareholders individually waive their pre­emption rights relating to the proposed new allotment.

What if you get it wrong?

Directors must not exercise any power to allot shares without the requisite authority. If they breach this requirement then each director in default is guilty of a criminal offence. However, the validity of the allotment is not affected. The same is likely to be true where the company issues shares in breach of a restriction in its articles on the total number of shares which it can issue or where shares are issued in breach of existing shareholders’ pre­emption rights.  In either case, the existing shareholders may be able to bring a civil claim against the company and/or the directors for breach of the articles and the company (directly or via the shareholders bringing a claim on behalf of the company) may be able to bring a civil claim against the directors personally for breach of their directors’ duties, in particular the duty to act within their powers.

What happens next?

After new shares have been allotted, the company’s statutory books must be updated to record the allotment, share certificates should be issued to the new shareholders, Companies House must be correctly notified of the allotment within the relevant time period and a deed of adherence or a new shareholders’ agreement entered into.

The allotment process can be complex and, if you happen to be a director authorising the allotment, can carry significant personal risk if not done correctly. It can, however, be a useful way for a company to raise additional share capital and bring new investors on board. So if you are contemplating issuing new shares in your company, don’t be put off but do take legal advice early on as this will be the best way to protect yourself and your business.