FounderCatalyst

A dividend is an optional payment a company makes to shareholders from its profits (“distributable reserves”), usually in cash, and often declared as a final dividend after year-end and approved by shareholders.

Share rights (incl. dividends)

There are 4 rights associated with shares:

Voting rights: Allow shareholders to vote on key decisions such as electing directors; investors usually expect voting rights and often resist non-voting shares.
Capital distribution rights: Give shareholders a claim on company assets if the business is liquidated; a preferential payout order counts as a preference for SEIS except in Liquidation Priority on Exit.
Pre-emption rights: Let shareholders maintain their ownership percentage by buying new shares before they are offered to others, protecting them from dilution.
Dividend rights: Let shareholders receive a share of the company's profits in the form of dividends. A dividend right in a share class doesn't mean they are going to get a dividend unless the company declares one. Dividend rights are typically considered a preference for SEIS.

What dividends do investors want?

Firstly, angel investors typically aren't interested in receiving a dividend - they are interested in you growing the business and the angel finding an exit. Any hint that a founder doesn't plan on exiting the business at some point could be perceived as a bad sign - maybe a hint that you intend on growing a lifestyle business rather than ‘swinging for the fences’ and exiting as soon as possible.
Investors will certainly want to make use of SEIS/EIS if they can. In order to qualify for SEIS or EIS, the investor has to incur the “normal risks of an investor” - they can’t get a better deal than any other shareholder and this is where dividends can risk S/EIS eligibility.

Dividends and SEIS

Per the HMRC manual, shares issued under the SEIS and EIS schemes must carry:

“no present or future preferential right to dividends where either:

The rights attaching to the share include scope for the amount of the dividend to be varied based on a decision taken by the company, the shareholder or any other person. Note: this exclusion covers only those shares which carry preferential rights and does not therefore prevent the voting of dividends in respect of non-preferential shares, nor does it prevent shareholders from choosing to waive a dividend payment should they wish to do so; or
The right to receive dividends is ‘cumulative’ - that is, where a dividend which has become payable is not in fact paid, the company is obliged to pay it a later time, normally once funds become available.”

Examples of a preference

A right carried by a share is a preferential right if it takes priority over a one carried by another share. ie: right to something in advance of another shareholder. HMRC is clear that one share class having a dividend right and another not, is not a preference.

Creating a preference can affect existing S/EIS shareholders. For example, Abingdon Health Limited v HMRC [2016]. The company made three EIS share issues from 2012–2014 and later created A ordinary “growth” shares for senior management. HMRC withdrew EIS relief, arguing that amendments to the Articles made at that time gave EIS shareholders priority on a winding-up.

The key point in relation to dividends is that Abingdon Health Limited operated multiple share classes, each with its own distinct rights - this is a preference. Whereas a scenario in which one class alone enjoyed a particular right that another class lacked is not a preference.

Examples of what is not a preference

As shown above, where a company has two classes of issued share capital, and dividends are declared on one class but not on the other, the right of the former class is not a preferential right.

HMRC guidance at VCM12020 specifically refers to deferred shares (albeit in a liquidation context but the principle is the same for dividends). That guidance expressly states that where dividends get 1p per share after the first £20m has been distributed, HMRC do not see that as a preferential right. As this is the case, we can be certain for a preferential right to exist, there must be two classes of shares which have rights, with one taking preference over the other. If there are no rights to dividends for one share class it can’t have preference over another.

In the HMRC v McQuillan case from 2017 it was held that a right to a dividend of nil was not a right to anything at all and therefore such shares do not have a right to a dividend. If there are no rights to dividends for other share classes, it cannot be said that one share class has a preference over another.

What if investors require dividends?

As mentioned above, it’s unusual for investors to seek dividends - their primary goal is typically an exit. However, in certain industries, such as hospitality, exits are less frequent, so investors may prefer an income return.

We know that S/EIS rules prevent us from giving preferential rights to S/EIS shares. This means we can’t distribute dividends to one share class while excluding another. However, we could remove the right to dividends for founder shares - there’s no “preferential right” as the founder shares don’t have a right to dividends. Under this structure, investors can receive dividends up to an agreed satisfactory point. Then, once Period B has passed, the company could pass a special resolution to reclassify the founder shares to include dividend rights. Importantly, making this change after Period B ensures that S/EIS compliance remains intact.

Tax investors pay on dividends

Dividends paid on SEIS shares are taxable, and SEIS relief does not extend to making dividends tax-free for investors.

Use of SEIS funds to pay dividends

The payment of dividends out of funds raised by the share issue is not permitted however, since the money would then not be employed for the purposes of a qualifying trade.

Dividend flexibility in the FounderCatalyst paperwork

Almost all customer choose “No” but if you select “Yes” 4.6 is pulled into the paperwork.

Knowledge Base: Dividends