Bonus shares, also known as a scrip issue or capitalisation issue, are additional shares distributed to existing shareholders free of charge. Companies often resort to issuing bonus shares when they lack sufficient cash to pay dividends but wish to reward their shareholders. Private companies in the UK can significantly benefit from this strategy, and we outline why it can be a sound option.
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Enhancing Shareholder ValueIssuing bonus shares is an effective way to reward shareholders without impacting the company’s cash flow. By increasing the number of shares held by each shareholder, the perceived value of their investment grows. This move can strengthen the relationship with shareholders and increase their loyalty to the company.
Capitalising Retained EarningsWhen a company issues bonus shares, it capitalises its retained earnings or reserves. This allows the company to reinvest its profits while providing value to shareholders. Transferring retained earnings into share capital can improve the company’s financial structure and present a more attractive image to investors, without depleting the cash reserves.
Market Perception and Share LiquidityBonus shares can positively impact a company’s market perception. It often signals to the market that the company anticipates a rise in future profits, thereby potentially boosting investor confidence. Furthermore, increasing the number of shares can enhance the share liquidity in the market, especially beneficial for larger private companies with multiple shareholders.
Making Future Dividends More AffordableWhen a company issues bonus shares, it increases the number of shares outstanding. As a result, future dividends will be spread across a larger number of shares, potentially making dividend payments more affordable for the company. This could be an advantage for companies planning to start or increase dividend payments in the future.
Maintaining Control within the CompanyFor private companies wary of diluting control, bonus shares provide an alternative to raising funds via new equity issuance. Since bonus shares are only issued to existing shareholders, they do not alter the ownership percentages. Therefore, the existing management maintains its control over the company.
Tax EfficiencyIn the UK, bonus shares can offer tax efficiency for both companies and shareholders. Companies do not have to pay Corporation Tax on the capitalisation of reserves, unlike cash dividends. Similarly, shareholders do not have to pay Income Tax on receiving bonus shares, as they might with cash dividends. However, they may be liable to pay Capital Gains Tax when they sell the shares.
