A company is a flexible corporate structure that can change its shareholding. Shares can be issued by the company to a new shareholder, or current shareholders can transfer (or sell) their shares to another party. While this is a relatively straightforward concept, whether the company issues new shares or transfers existing shares will have different implications for the company and its shareholders. Additionally, the process will vary depending on whether a shareholders’ agreement is in place. This article will discuss the difference between a share issue and a share transfer.
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What is a Share Issue?
A share issue is when the company creates new shares, which it distributes to shareholders. After the share issue, the total number of shares in the company increases. Share issues are common when a company is raising money through equity financing. Convertible notes and SAFEs are examples of convertible security issues which ultimately result in a share issue. In these situations, shares are not issued immediately but instead on certain future trigger events.
What is a Share Transfer?
A share transfer is where a current shareholder transfers (i.e. sells) their shares to another party. Absent a shareholders agreement or restriction in the company’s constitution, shareholders are free to sell their shares to anyone. In practice, this is the buyer prepared to pay the highest price.
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We recommend that companies have a large number of shares from the outset (such as 100,000 shares). This makes it easier to apportion shares in the future. |
What Are the Differences Between a Share Issue and Share Transfer?
A share transfer involves two individuals transacting privately. The company is not a party to the transaction. Whereas, in a share issue, the company is essentially transferring shares in exchange for cash.
While this may seem to be a straightforward distinction, you may find situations where the position is less clear. For example, a company with two 50% shareholders may look to bring on a third shareholder as a partner so that all three shareholders own 33% of the company. A share issue in this situation may make the most sense. However, it will require both shareholders to be in agreement as to the value of the shares and will require both shareholders to waive their pre-emptive rights. Following the share issue the total number of shares in the company will be increased.
Further Considerations
On the other hand, a share transfer would mean that both shareholders can each sell 1/3 of their current shares to achieve a similar result. The money is paid to both shareholders personally. There does not necessarily need to be a valuation that takes place as both shareholders can freely choose the value they attach to their shares (assuming there is no shareholders agreement).
Following a share issue, new shares are created, and every current shareholder experiences a dilution effect. While they will retain the same amount of shares, the current shareholders will have their percentage shareholding decreased in proportion to the new shares that are issued. Dilution is often a natural event for the company, and usually, shareholders agree to waive their pre-emptive rights when the company undertakes a capital raising process as the capital helps the company expand and further increases the value of the current shares. However, if there are issues of a particular shareholder wanting to maintain their control, they should be mindful that a share issue will decrease the level of control that they have over the company. Unlike a share issue, a transfer does not create any new shares, and therefore, there is no dilution process which takes place.
Legal Differences
No Constitution or Shareholders Agreement
The default rules under the law do not provide for any pre-emptive rights on share transfers. There are, however, pre-emptive rights for share issues under the default rules. The company will need to obtain waivers of pre-emptive rights for current shareholders whenever the company seeks to issue new shares.
Shareholders Agreement
A shareholders agreement usually provides a more comprehensive process for both share transfers and share issues than the default rules. The main advantage of a shareholders agreement (or constitution) is that you can ensure there are pre-emptive rights on share transfers as well as share issues. The usual process is that if a shareholder wishes to transfer their shares, they must first offer their shares to existing shareholders. These existing shareholders can then exercise their pre-emptive rights to buy the shares. This prevents you from selling your shares to unknown third parties.
Key Takeaways
A company has flexibility in changing its shareholding by allowing shareholders to transfer their shares or issuing new shares to new investors or business partners. The main difference between a share transfer and a share issue is that:
- a share transfer will mean that the shareholder sells the shares, and it is the shareholder who receives the money;
- whereas with a share issue, new shares are created and issued to the new shareholder in exchange for the new shareholder paying their money into the company.
Depending on whether the company has a shareholders agreement, there are also different rules around pre-emptive rights for share transfers.
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Frequently Asked Questions
Not necessarily. A SAFE will convert on a liquidity event or a pre-agreed “trigger” event If neither of those events occurs, the SAFE will not convert.
If the SAFE agreement contains all the elements of a binding contract, then it is legally enforceable.
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