The allocation of bonus shares, also known as a scrip issue or capitalisation issue, is a well-established method employed by businesses to distribute surplus profits to shareholders without actually parting with liquid cash reserves. For private companies in the UK, issuing bonus shares is a strategic option that presents several advantages. Let’s delve into why such a decision can be beneficial for private enterprises in the British corporate landscape.
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Retention of Cash Reserves
Perhaps the most apparent benefit of issuing bonus shares is the conservation of cash reserves. While rewarding shareholders, the company is able to hold on to its cash, which can be deployed towards business expansion, R&D, handling unexpected expenses, or other strategic initiatives. This is particularly valuable in volatile economic environments or industries where significant capital expenditure is required.
Increasing Marketability of Shares
Bonus shares, by virtue of increasing the number of shares in circulation without altering the company’s net worth, lead to a decrease in the share price, making them more affordable for potential investors. Even though private companies don’t trade on the open market, a lower share price can increase the marketability of shares to new private investors, facilitating fund-raising.
Enhancing Shareholder Confidence
The issuance of bonus shares signals a company’s healthy financial status and profitability. It signifies that the company has accumulated substantial reserves and is confident enough in its future prospects to distribute these profits to shareholders. This can bolster investor confidence and demonstrate a commitment to shareholder wealth maximisation, which can contribute to the company’s long-term stability.
Capital Structure Reorganisation
Bonus issues enable the reorganisation of a company’s capital structure without impacting its overall equity. If a company has substantial free reserves and a small share capital base, issuing bonus shares can help bring share capital in line with the size of the company’s assets. This can lead to a more balanced capital structure, which can enhance the company’s financial stability and appeal to potential investors.
Tax Efficiency
In the UK, bonus shares are generally not treated as income but as a return of capital, which may lead to capital gains tax (CGT) implications instead of higher-rate income tax. The current CGT rates are typically lower than the top-tier income tax rates, making bonus shares a potentially tax-efficient way of distributing profits to shareholders.
Serving as a Dividend Substitute
If a company wants to reward shareholders but doesn’t want to establish a pattern of regular cash dividends, bonus shares can serve as an excellent substitute. This offers the benefit of a ‘dividend’ without the financial pressure of ongoing cash commitments.