15 February 2024

The Lifecycle of a Business – Dividends

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

Dividends

Our recent articles have referred to the payment of dividends to shareholders . In this article, we delve into how profits and retained earnings of a private company can be distributed among its shareholders by way of dividend. We discuss when and how much may be distributed and also look at restrictions that might apply to private companies (the additional restrictions placed on public companies with respect to dividends are out of scope of this particular article).

What are dividends?

Dividends are a type of distribution made by a company to its shareholders and are a way of returning some of the profits of a company directly to its shareholders. They’re generally paid in cash, but might also be non-monetary payments such as shares in the company (scrip dividends) or physical assets (dividends in specie).

Where a company declares a dividend, and that company has only one class of share in issue, it must declare and pay dividends equally on each share. Companies with more than one class of share in issue may wish to allocate different dividend rights to each class.

When can dividends be paid?

A company may only distribute dividends out of the profits available to it for any such distribution, that is, the company’s accumulated, realised profits, less its accumulated, realised losses, as they are stated in the company’s annual, interim, or initial accounts (as the case requires). In other words, the company must have sufficient distributable profits to pay the dividend.

As to timing, a dividend can be paid at any point in time but will generally be paid:

  • as a final dividend once the company’s end of year financial statements have been prepared. This usually requires shareholder approval, often at the company’s annual general meeting; or
  • as an interim dividend at any time during the financial year before the company determines its annual profits. This does not usually require shareholder approval.

Special or “one-off” dividends can also be paid as and when appropriate.

Amount of any dividend

Provided there are sufficient distributable profits available to the company to cover any payment of any declared dividend, and its constitutional documents allow it, there is no restriction as to the amount of dividend that may be declared and distributed to a company’s shareholders.

Declaring a dividend

The manner in which a company may declare a dividend (if at all) will usually be set out in its articles of association or in a shareholders’ agreement in relation to that company and these should always be checked before declaring any dividend.

There is no legal obligation on the company or its directors to declare a dividend. As such, a company may decide to use its profits for other purposes, for example, as working capital, to invest, to pay dividends at a later date (retained earnings), to cover any unexpected circumstances that might arise, to reinvest in its business for growth and expansion, or to pay down debt.

Final dividends

A final dividend usually requires the approval by ordinary resolution of the company’s shareholders (where the directors have resolved to recommend the amount of any such dividend). This approval is usually obtained at the company’s annual general meeting at which the annual accounts are also approved.

Once a final dividend has been declared by its shareholders, it becomes a debt due and payable by the company on the date of the resolution, unless some future date for payment is specified.

Interim dividends

Provided that the company’s articles of association or any shareholders’ agreement allows, the directors may decide to pay interim dividends at any time, provided that the company has sufficient distributable profits. (It should be noted that the model articles of association permit the payment of interim dividends by default.) The company’s annual and interim accounts will likely be produced at the board meeting at which the interim dividend is to be approved.

An interim dividend may be varied or rescinded at any time after it is declared and before payment is actually made and may, therefore, only be regarded as due and payable when it is actually paid.

Tax implications

The payment of a dividend by a UK company is not deductible when the company’s taxable profits are computed.

Generally, there is no withholding tax when a UK company pays a dividend (although there are exceptions for some types of investment funds).

When a company may not pay a dividend

A company’s articles of association or any shareholders’ agreement in force in relation to a company might place certain restrictions on the directors’ and/or shareholders’ ability to make dividends.

In addition, dividends which contravene certain sections of the Companies Act 2006 (the Act) (for example, one declared where a company does not have sufficient distributable profits) or common law (for example, a distribution out of capital) are classed as unlawful dividends and should not be paid.

Consequences of making an unlawful dividend

Where the directors declare and distribute a dividend in circumstances where there are insufficient profits available to distribute, they will likely be in breach of their statutory duties contained in the Act, such as their duty to promote the success of the company for the benefit of its shareholders as a whole, or their common law duty to consider the interests of the company’s creditors (rather than the shareholders) in circumstances where the company is facing insolvency (our article, “A Balancing Act – when do directors owe a duty to creditors?”, considers the circumstances when a director owes a duty to creditors following the Supreme Court judgment in BTI v Sequana). This could have various adverse consequences, including disqualification as a director.

No criminal penalties attach to the payment of unlawful dividends, but a director could be held personally liable to repay the company. For further information about this, please see here.

Paying a dividend when the company is insolvent or subsequently becomes insolvent could also have consequences under insolvency law.

Takeaways

Paying dividends can send a positive message about a company’s current financial strength and future prospects. Many investors like the income associated with dividends and so may be more likely to invest in a company that pays regular dividends.

On the other hand, a company that is still growing should carefully consider whether paying a dividend is advisable; it may be preferable to instead reinvest any profits into its future growth, pay off some debt or use the profits for working capital purposes, for example. And, as discussed above, a company that doesn’t have sufficient profits shouldn’t declare a dividend in the first place; doing so could result in the directors being held personally liable to repay the company.

The decision whether to pay a dividend or not may not be clear-cut. Directors must consider their statutory duties, as well as the financial situation of the company, its constitutional documents, and any tax implications. Speaking to your legal advisor or accountant (or both) is advisable in this situation.

Disclaimer

This note reflects the law as at 14 February 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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