Considerations on allotment of shares

The s.755 restriction

Under s.755 CA 2006 a private company limited by shares is prohibited from offering its shares to the public. As a result, private companies are essentially restricted to offering their shares to targeted investors only and not to the public indiscriminately.

The expression ‘offer to the public’ (as defined in s.756 CA 2006) covers offers to ‘any section of the public’, but excludes offers which are intended only for the person receiving them, and offers which are a ‘private concern’ of the persons making and receiving them. This latter exclusion covers offers made to existing shareholders, employees of the company and certain family members of those persons, and offers of shares to be held under an employee’s share scheme. These excluded offers will not fall foul of the s.755 restriction.

This restriction must be considered carefully when a private company is proposing to allot shares.

The requirement for a prospectus

Every time that a company (private or public) offers shares you will need to consider whether or not it is required to publish a prospectus to would-be investors. Below is a very brief overview of the rules relating to prospectuses.

What are the governing rules?

At the time of writing, the rules on prospectuses are derived from the European Union’s Prospectus Directive (the ‘Directive’), as amended by subsequent amending directives, which affects, amongst other things, the content and disclosure requirements for prospectuses.

The Directive has been implemented in the UK through the Prospectus Regulation (which has direct effect in the UK); the Prospectus Regulation Rules (PRRs) drawn up by the City regulator, the Financial Conduct Authority (FCA) and amendments to the Financial Services and Markets Act 2000 (FSMA).

Where shares are being offered overseas, overseas law must be considered, and you should note that within the European Economic Area (EEA), mirroring provisions will apply.

Note that the rules on prospectuses are also relevant to offers of debt securities.

What is a prospectus?

A prospectus is essentially an explanatory circular giving investors details about the company they are investing in and about the investment itself on which to base their investment decision. A prospectus should contain all the information necessary to enable investors to make an informed assessment of the financial status of the company and the rights attaching to the shares (s.87A(2) FSMA), and preparing a prospectus is therefore an expensive and time-consuming process.

When is a prospectus required?

In an offer of shares by a private company, it will usually be the case that a prospectus will not be required. However you will need to consider the rules each time.

In outline, the legislation sets out two tests. If either test is satisfied then the company will have to publish a prospectus which will need to be approved by the FCA.

In summary, the tests (set out in s.85 FSMA) are whether the shares are:

1. being offered to the public in the UK (s.85(1) FSMA); or
2. being admitted to trading on a regulated market in the UK (s.85(2) FSMA).

The definition of ‘offer to the public’ for the purposes of the first test (set out in s.102B FSMA) is very wide and capable of covering a range of communications that are not intended to be offers to the public (such as a newspaper article by a financial journalist). Note that (because of the differing definitions of ‘offer to the public’) it is possible that a private company could offer shares to investors without contravening s.755 CA 2006, but that a prospectus could still be required. Usually, however, a private company will be able to rely on one of the exemptions set out below.

For the purposes of Test 2, the Main Market of the London Stock Exchange is a regulated market, although AIM is not. A private company will clearly only be concerned with Test 1, not with Test 2.

Are there any exemptions?

There are different exemptions for Test 1 and Test 2. The Test 1 exemptions are referenced in s.86(1)(aa) FSMA and the PRRs 1.2.3R Article1(4).

The exemption most likely to be relied upon by a private company is the exemption for offers made to or directed at fewer than 150 persons (other than ‘qualified investors’), per EEA State. This exemption will cover the vast majority of share offers by private limited companies.

Another exemption of particular application to offers by private companies is that covering offers made to or directed at ‘qualified investors’ (as defined in the Markets in Financial Instruments Directive (MiFID), essentially covering certain professional or institutional investors) only.

Financial Promotions

Under s.21 FSMA a financial promotion is any invitation or inducement (in the course of business) to engage in investment activity (which includes buying shares). Financial promotions are prohibited (for all companies) unless certain requirements set out in FSMA are fulfilled. Clearly this is potentially relevant when a company is considering issuing shares to investors. Communications made by a company when issuing its shares must, either be within an exemption from the s.21 FSMA prohibition, or be issued or approved by an authorised person.

Price for shares

In simple terms, the price of a share is calculated by working out the value of the company as a whole and dividing it between the number of shares in issue. This will give a value per share, which can be used to determine the price.

There are various ways in which a company can be valued. For example: the ‘Balance Sheet’ valuation, looking at the value of the company’s assets minus its liabilities, or the ‘multiplier’ valuation, looking at the average profit of a company and multiplying it by a factor relevant to the particular industry. The value of a listed company (known as its ‘market capitalisation’) can be ascertained by multiplying the number of shares in issue by the share price at a given time.

The price of a share will comprise the nominal value of the share, plus a premium, although shares can trade at a discount to nominal value (which does not contravene the prohibition on their issue at a discount).

Effect of issuing a share for more than its nominal value on the Balance Sheet

Blue Moon Limited issues an additional 100 £1 ordinary shares for 150p each in cash, i.e. at a premium of 50p per share.

Blue Moon Limited Balance Sheet as at [date]
	Before issue	After issue
ASSETS (cash)	100	250
Less LIABILITIES	(0)	(0)
NET ASSETS	100	250
SHARE CAPITAL	100	200
SHARE PREMIUM ACCOUNT		50
RETAINED EARNINGS	(0)	(0)
SHAREHOLDER FUNDS	100	250

The cash received is shown by an increase in the assets. The nominal amount of the new shares is shown by the increase of 100 in the share capital. The premium of 50p per share (totalling £50) is shown in the newly-created share premium account. The share premium must be shown in a separate share premium account pursuant to s.610(1) CA 2006.

Earnings per share

‘Earnings per share’ is a commonly used ratio that can be used to measure the financial performance of a company. It shows the return due to the ordinary shareholders and is calculated by dividing profit after tax by the average number of ordinary shares in issue whilst the profit was generated. An increase in the number of shares in issue will result in a dilution of the earnings per share figure.