“A share is the interest of a shareholder in the company measured by a sum of money, for the purposes of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders in accordance with the laws.”

The above is the most commonly understood definition of shares. However, it is better to understand the function of a shares by an example as follows:

ABC Company Limited will be set up for running businesses usually have capital (cash and other assets) put into it by the shareholders in return for shares. 3 shareholders A, B and C set up a company and agree that each put in HK$10,000 as share capital. The most common way to represent this distribution is that the company issues 10,000 ordinary shares with value HK$1 to each of the three shareholders. The company’s issued share capital will then be HK$30,000 divided into 10,000 shares of HK$1 each.

At the same time a share is itself an item of property which (subject to the company’s articles) can be transferred by sale or gift.

Please note that this is not the only solution. In practice, the company may issues 10,000 ordinary shares with value HK$1, and then the shareholders would take one share each (i.e. evenly distributed) and to lend money to the company as capital.

We have come across a term “Share Capital” and it is an important area that must settled during incorporation:

The capital of a company limited by shares incorporated in Hong Kong must be divided into shares. The company is a separate legal entity so the company is regarded as selling its shares to the shareholders who pay for them in cash or other assets. The creditors of the company can usually look at the company’s assets for payment, share capital is “locked” into the company and can be returned to the members only subject to the strict rules of a shares buy back or reduction of capital. The shareholders are the members of the company and are the owners of it.

For a company limited by shares, shareholding is the expression of legal power of shareholders varies in proportion to the shares which are being held respectively. In other words, system of joint ownership, the shareholders jointly own the company.

50% and over shareholding gives dominant controlling power to a company such as firing a director and force out minority stockholders by acquiring their shares as per the rules of the firm.

75% of shareholding gives holders the power to amend the articles of association and the firm’s name, reduce the share capital, allow the firm to buy its own shares from other stockholders, and to shut down the business.

100% percent shareholding (a.k.a sole shareholder) gives total power under the company regulation.

As a shareholder getting the return of investing in a company, they are rewarded  a set of rights in the company which may vary according to the type of shares acquired. Generally, private companies only have one class of shares (i.e. ordinary shares), some of the companies issues more than one class of shares. The creation process is on paper, this is done by setting out the various rights for the various classes, and usually written in the company’s articles. Truly understands rights of different class of shares is essentially a matter for the company to determine for shareholders to invest into as well as joint owning a company.

Specific rights of shareholders of a company can be included in the Articles of Association, here is the general understanding of the rights attached to shares which would normally included in the Articles of Association:

• They are entitled to receive dividend of the company when profits are available.
• The company undergoes winding-off, they are entitled to the company’s surplus of assets  after all the debts incurred have been paid off.
• Various shares may carry the right to vote only in particular circumstances where the company has different classes of shares. In general, shares carry one vote each at general meetings but there may be non-voting shares or shares with multiple votes.

• Investment as capital injection. By subscribe to the shares of a company to ensure that the company can have a capital to run the business. As long as the shares are fully paid, that is the end of the shareholders’ obligation to the company. However, if the shares are only partly paid at the time it was subscribed, the shareholders would have the liability to pay the balance when the company calls the shareholders to pay, or when the company is wound up.
• Personal liability. A company must have at least two shareholders. If a company carries on business without having at least two shareholders and does so for more than six months, a person who is a shareholder of the company and knows that it is carrying on business with only one member is liable to pay the debts of the company incurred from the expiry of that 6 months period. The liability is joint and several with the company.

Different classes of shares within a company often have rights attached:

• Voting rights
• Dividend rights
• Capital rights

Usually, the company may has reasons to consist of different shares at the same time:

• To attract a particular investor: by giving a person preference shares.
• To pay as dividends: by giving “non-voting shares” to family members or employees so that dividends may be paid to them, but to restrict the rights attached to such shares.
• To protect the capital rights of particular owner: by giving “priority shares” to the family members of the company’s founder so that they have the priority to receive capital if the company goes winding-up.

Here is a general and common descriptions of some typical classes of shares, legal definitions of such classes and shares with the same name (e.g. preference shares) will have different rights in different companies.

• Ordinary shares: Most of private companies have only ordinary shares, they carry one vote per share, are entitled to equal participation in dividends. When the company is wound-up, all the company’s debts must be paid by the company’s assets before they can share the company’s assets.
• Preference shares:  They are often non-voting, usually give preferential right to a fixed amount of dividend expressing as a percentage of the nominal (or, par) value of the share. It is  still a dividend and payable only out of profits. Sometimes, the dividend may be cumulative (i.e. the unpaid dividend of a year accumulates to the next year) or non-cumulative. The dividend is usually restricted to a fixed amount but alternatively the preference share may be participating.
• Deferred ordinary shares: No dividend is paid until other classes of shares have received a minimum dividend.
• Non-voting shares: No rights to vote and no right to attend general meetings. They are commonly issued to employees as part of their remuneration in terms of  dividends.
• Redeemable shares: Special terms attached to the shares, usually the company will buy them back in a specific date in the future, the date may be fixed or at the directors’ discretion. Redemption price is often agreed to the same as or higher than its issue price.
• Management shares:  This class of shares carries extra voting rights for particular holders to retain controlling of the company. This may be done by conferring multiple votes to each share or by enjoying a lower nominal value for such shares so that there are more shares (and so more votes) per £1 invested. Such shares are often used to allow the original owners of a company to retain control after additional shares have been issued to outside investors.

In the case of more than one of members are jointly investing into a company, usually namely three classes of shares are issued for ease of management:

• Class ‘A’ enjoying 100% of the Voting rights
• Class ‘B’ enjoying 100% of the Dividend rights
• Class ‘C’ enjoying 100% of the Capital rights

Then, the different shareholders to “mix” and own different percentages of classes of shares for the purposes of distribution of rights.

For example, a company consists of 2 shareholders, and they want to distribute the 3 types of right among different members.

• Shareholder 1 has 40% of ‘A’ shares, 50% of ‘B’ shares and 60% of ‘C’ shares.
  i.e. 40% voting rights, 50% dividend rights and 60% Capital rights.
• Shareholder 2 has 60% of ‘A’ shares, 50% of ‘B’ shares and 40% of ‘C’ shares.
  i.e. 60% voting rights, 50% dividend rights and 40% Capital rights.

According to Companies Ordinance, statutory protection is given to the shareholders of a class of shares against the rights on their shares being altered.

However, some minority classes of shares or  classes of non-voting shares would be vulnerable to the rights on those shares being altered by the majority by altering the articles of association via passing of special resolution.This process is known as a variation of class rights which is a complex issues any may varies according to the company’s articles, the following is a summary of the major statutory solution:

• shareholders of three-quarters in nominal value (par value) of the issued shares of that class consent in writing to the variation; or
• a special resolution is passed (75% majority of voting shares) at a extraordinary general meeting of the holders of that class to sanction the variation.

It should be almost impossible to be done because there is no statutory procedure for converting shares from one class to another. However, it may be done with the consent of all the shareholders affected.

Here is a practical suggestion, it may be done by passing a special resolution to which all the shareholders consent the change of a shares’s rights because changing the rights on one shareholder’s shares may have an effect on the rights of all the other shareholders.

You may find the above solution requires passing of special resolution. Alternatively, you may sell out the existing shares to the company and buy in another class of shares.

As a general practice, paying a dividend is the usual way for a company to distribute a share of its profits among the shareholders. According to Companies Ordinance, the company can make no distribution (including dividends) to shareholders when the company is out of profits.

For the method of dividends distribution, the practice varies widely in private companies limited by shares. When the company is making profits, it is essentially to share the profits to the shareholders (who own the company) and to the director (who “steer” the company).

Should the company pay director(s) by solely dividends instead of bonus when profit is available?

The company’s profit is expected to be shared to directors, apart from regular salaries, bonus is often given as rewards for the directors’ work done for the company.

The other way of sharing company’s profit is paying dividends. These are paid to shareholders (a director can be the a shareholder) and must be paid in accordance with the rights of the respective shareholders unless the company has special arrangement according to articles). Dividends are taxable as investment income in the shareholders’ hands. The tax rates for dividends are generally lower than for other sources of income.

According to Hong Kong tax law for businesses, a company’s dividends is the after tax profits among shareholders, while directors’ salaries, wages, bonus and benefits are the expense of the company, such money will be regarded as the expense of the company and such transaction is deducted from the company’s revenue before taxation.

For a private company doing business in Hong Kong to give payment to directors as sharing of profits, paying directors by bonus (i.e. salaries) while avoiding giving dividends is the best tax efficient approach.

The company may not pay interest on any dividend in respect of a share unless otherwise provided by:

• the terms on which the dividend was issued, or
• the provisions of another agreement between the holder of that share and the company.