When business owners talk about giving their husband or wife shares, what they usually mean is not about control or voting rights. Don’t tell HMRC, but it is usually about income.
They want to be able to pay dividends to their spouse in a tax efficient way, without giving away the steering wheel of the business. That is what alphabet shares are really used for.
Alphabet shares are simply different classes of shares in the same company, each with its own dividend rights. Instead of every share receiving the same dividend, the directors can declare different amounts on different classes. That means you can decide, each year, how much income goes to which person.
So you might have A shares for you, B shares for your spouse, C shares for a holding company, and so on. Everyone is in the same company, but the money can be split in a flexible way.
A real world example
A good example is a professional services firm with two founders.
The share structure might look something like this:
- Each founder has their own class of shares (A+B)
- Each founder’s spouse has their own class of shares (C+D)
- Each founder also has a personal service company or holding company that owns another class of shares (E+F).
That means the company might have six or more classes of shares, all in the same firm.
Why do this?
Because it allows the founders to decide, each year, how profits are split. Some income might go to the founders personally. Some might go to their spouses. Some might be paid into their holding companies, where it can be reinvested or extracted later in a tax efficient way, including taking advantage of tax free dividends within the corporate group.
The holding companies can also have their own alphabet shares internally, so each founder can then split income again inside their own structure in whatever way suits their family and tax planning.
It looks complicated on paper, but commercially it is just a very controlled way of saying: this is how we want to share the profits this year.
What has to be done legally
You cannot just decide this informally. The company has to be set up to allow it.
The articles of association need to create the different classes of shares and set out their dividend rights. New shares then need to be issued to the relevant people and companies. That means board resolutions, share certificates, registers of members and filings at Companies House.
There can also be tax consequences when shares are issued or transferred, even between spouses, so this should always be checked rather than assumed.
Once that is done, the directors can declare different dividends on different share classes as and when they choose.
That is the mechanism that makes alphabet shares useful.
I can help you set up alphabet shares.
Why a shareholders agreement is still vital
Where people often fall down is assuming that because the share rights are written into the articles, nothing else is needed.
In reality, the articles only deal with what the shares are. They do not deal with what happens to them when life intervenes.
One of the biggest risks is death.
If one shareholder dies and there is no shareholders agreement, their shares form part of their estate. They are tied up in probate and eventually pass under their will. That could mean their spouse, children or even someone else entirely becomes a shareholder in your business. In the meantime, the shares are often frozen and no one can vote them or deal with them properly.
That is not just messy. It can be commercially dangerous.
A well drafted shareholders agreement usually deals with this very differently. It will say that if a shareholder dies, their shares are automatically transferred to the other shareholders or to the company. The deceased’s estate is paid out, usually using life insurance or relevant life cover that has been set up for this purpose.
So instead of the shares drifting into probate and family disputes, the ownership of the business stays clean and the family gets cash.
That is a huge difference in outcome.
The same agreement can also deal with divorce, exits, disagreements, and what happens if someone stops being involved in the business.
So even if your co-shareholders is your wife, your husband or your best mate – a shareholders agreement is still one of the best investment you’ll make.
Conclusion
Using alphabet shares to give your husband or wife a stake in the profits of your business can be very sensible. Used properly, they allow families to share income and build long term wealth in a flexible and tax efficient way.
But they only work well if the legal structure around them is thought through. That means not just issuing the right classes of shares, but also putting a shareholders agreement in place that deals with death, succession and the realities of human life.
Most people do not plan to fall out, get divorced or die. Businesses that last are the ones that plan for it anyway.
If you’re thinking about issuing alphabet shares, or just want sound advice on structure, then get in touch.