Shares show ownership of a limited company. For small companies, the business owner is often the only shareholder. But sometimes, business owners might sell shares to other people or companies. These shareholders might own different percentages of the business, meaning they get paid varying amounts (called dividends) from the company’s profits.
This guide will answer the following questions:
- How do dividends work?
- Can you pay different dividends to shareholders?
- What are the benefits of issuing dividends?
- How do you issue dividends to shareholders?
- What if you want to change a share class?
- How does Countingup simplify small business finances?
How do dividends work?
Dividends are sums of money that a limited company pays out to shareholders in the company when the business makes a profit. Companies that consistently pay out dividends tend to be the most stable over time since they attract more investors to help fund them.
As the director of your company, you could pay part of your wage in dividends. Taxes are lower on dividends than a salary, which is why many business owners choose to subsidise their wages with dividends. You can learn more about how to pay yourself in dividends at the end of this article.
Limited companies are the only ones that issue shares, meaning they’re the only ones that can pay out dividends. Sole traders, partnerships and LLPs (limited liability partnerships) don’t issue shares, meaning they can’t pay out dividends.
Can you pay different dividends to shareholders?
The short answer is yes. But to pay unequal dividends, your shareholders must hold different classes of shares. The different classes of shares that limited companies can issue are called ‘alphabet shares’.
These different shares (A shares, B shares, C shares and so on) can each be assigned different rights, such as voting rights or the percentage of dividends the shareholder of that particular class of share can get.
For example, a Class A shareholder might receive dividends at a different rate than a Class B shareholder, and a Class C shareholder might receive the same dividend as Class B shareholders but have different voting rights on business decisions. Structuring your shares this way will give you a variety of dividend payouts and voting rights to suit each shareholder.
Suppose you only want the dividend distribution to be the only difference between the classes of shares. In that case, you can convert shareholder shares to a different class to allot them the appropriate amount of dividends according to what they invested.
What are the benefits of issuing dividends?
Dividends are a fair and simple way to divide company profits by share ownership. Using alphabet shares also allows companies to be more flexible in how they pay out dividends to shareholders. Rather than following an equal portions basis (often referred to as pro-rata), you can pay shareholders based on their investment and/or involvement in the business.
Using alphabet shares is handy if you want to appoint a family member as a shareholder to receive dividends without giving them voting rights. This system is also useful for investors who want to invest in a startup company and own the majority of it without needing to be involved in day-to-day operations.
These are perfect examples of how alphabet shares can be useful for a limited company and why you might want to issue different rates of shares. It’s worth noting that the sum a shareholder receives from a dividend affects the amount of tax they may need to pay.
Shareholders of a company (including yourself) don’t pay tax on dividend income that falls within the Personal Tax-Free Allowance of £12,570 in 2021/22. They also get a Dividend Allowance of £2,000 in the 2021/22 tax year. Anything over the total amount will get taxed at the following rates:
- Basic-rate taxpayers pay 7.5%
- Higher-rate taxpayers pay 32.5%
- Additional-rate taxpayers pay 38.1%.
How do you issue dividends to shareholders?
Before issuing a dividend to shareholders, companies must hold and keep minutes of a directors’ board meeting to ‘declare’ the dividend. If you’re the only director, you can’t call a board meeting but must still keep a record of your decisions and fill in the correct paperwork for declaring dividends.
For each dividend your company issues, you must issue a dividend voucher, which must include the following information:
- Date the dividend is paid
- Your company name
- Names of the shareholders you pay the dividend to
- Dividend amount
Keep one copy of the voucher for your records and give another copy to each shareholder receiving the dividend.
You’ll issue the dividends according to the shareholder’s class of shares and how much they invested in the company.
For example, if a Class B shareholder typically owns 10% of the company shares, they receive 10% of the dividend distribution. If someone with Class A shares owns 15% of the company’s shares, then they receive 15% of the dividend, and so on.
What if you want to change a share class?
You need to let Companies House know as soon as possible once you’ve set up your shares. Remember that you must also report any changes you want to make to the shareholder structure. You’ll need to supply details of shares and rights each shareholder owns and what each class of shares includes when you do this.
Read some of our other guides to learn more about Companies House, dividend incomes, and how much dividend you can pay yourself tax-free when running a limited company.
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