Class rights - different share classes exist for shareholders

When investors take an equity stake in a company, it is very common for them to hold a different class of shares to those held by the management team - or, indeed, to those held by other types of investors. For example, if new investors come in at a later round of funding, they might subscribe for a different class of shares than the investors who provided the seed capital.

When people talk about different "classes" of shares, what this usually means is that the shares have different names (for example, ordinary shares, preferred ordinary shares, A ordinary shares etc) and, very importantly, have different rights, as regards matters such as dividends, voting rights and so on. There is also a distinction between equity shares and preference shares - the latter usually being non-voting, redeemable shares which attract a fixed return.

There are many reasons why different classes of shares are held by different types of shareholder - but one of these is so that what are known as "class rights" can attach to them. In brief, these are a list of things which cannot be done without the consent of a relevant proportion (normally 75 percent) of the holders of the shares of that class.

The Companies Act does contemplate statutory class rights - s125 provides that any variation of the rights attaching to a class of shares must have the consent of the holders of 75 percent of the shares of that class. However, because the Companies Act language is fairly general, it is pretty normal to have specific, tailor made class rights enshrined in the Articles of Association of the investee company. These are, in practice, vetoes which should operate in tandem with (and often overlap with) the rights set out in any shareholders' agreement. The usual sorts of things that one would provide cannot be done without the consent of the relevant class of shareholders would often include issuing further shares, changing the Memorandum and Articles, capitalising reserves, selling subsidiaries or businesses or winding up the company.

Obviously, the nature and extent of class rights vary very much from deal to deal. We have seen technology start-ups where there is just one class of shares with no special rights and no distinction made between the shares held by the management team and those held by the investors. However, if the nature of the transaction is such that the investors are in a position to require veto rights, then it is beneficial to those investors to have those rights enshrined in class rights in the Articles of Association as well as having vetoes in the shareholders' agreement. The main advantage of having vetoes in the Articles is that these will bind all shareholders (present and future) automatically.

If you would like any further information, please contact corporate partner David Day at [email protected] or on +44 (0)20 7367 2948.