Class of shares

Definition of a class of shares

A “class of shares” is a subdivision of a company’s capital that groups together shares or units with specific characteristics. These classes may differ according to various criteria: distribution policy (accumulation or dividend distribution), reference currency, voting rights, management fees, or risk profile.

It is thus possible to create different categories of shares (in a public limited company, S.A.) or units (in a limited liability company, S.à r.l.) that confer distinct rights on their holders: for example, differentiated voting or dividend rights, a veto right over certain strategic decisions, or special liquidation arrangements.

These categories must be provided for in the company’s articles of association (bylaws) and address specific needs: protection of a minority shareholder, allocation of preferential rights, or a profit-sharing plan for certain employees or executives. In the context of an S.à r.l., whose number of shareholders (associates) is limited (maximum of 100), creating classes of units mainly serves to organize governance and the distribution of profits in a way suited to the company’s relatively small structure.

The repurchase of a class of shares consists of a company—provided it has the necessary funds and authorizations—acquiring and possibly canceling certain previously issued shares, thus allowing it to restructure its share capital in a targeted manner. In practice, this mechanism first requires that either the articles of association or a general meeting of shareholders authorize the repurchase and establish its terms (price, number of shares in question, etc.). The shares must generally be fully paid-up, and the company must have sufficient reserves to finance the operation without affecting its minimum share capital. Once repurchased, the shares may be canceled, resulting in a capital reduction, or retained as treasury shares if allowed by law and the bylaws. When it involves a specific class of shares, the repurchase often aims to enable the exit of investors who no longer wish to participate in the governance or the capital, or to refocus the distribution of voting rights and dividends among the remaining shareholders.

What are share classes used for?

Share classes enable flexible and strategic structuring of the company’s capital to meet the specific needs of the company and its shareholders.

Below are a few examples of how different share classes might be used:

• Governance. A class of shares may be created without voting rights in order to limit certain investors’ influence on the company’s decisions. In exchange for the absence of voting rights, shareholders of that class may enjoy a preferred right to dividends or to a portion of the liquidation surplus.

• Attracting investors. Offering a class of shares with attractive financial rights (for example, a priority dividend or a fixed rate of return) may appeal to investors primarily seeking security or a stable return. This approach makes it possible to attract a broader range of investor profiles, while preserving a governance model aligned with the company’s needs.

• Protecting founders. Founders can create a class of shares granting them multiple voting rights, allowing them to retain control of the company even in the event of capital dilution. This category of shares can thus provide control over strategic decisions while still opening the company’s capital to other investors.

Share repurchase: advantages and risks

A share repurchase occurs when a company acquires all or part of its own shares held by its shareholders. When this mechanism is applied to specific classes of shares, it may have particular implications depending on the rights attached to those classes.

Various reasons may motivate a company to repurchase classes of shares:

• Optimizing cash flow. The repurchase can serve to distribute excess liquidity to the shareholders of a specific class, while avoiding a distribution in the form of dividends. It is therefore a tool for managing financial resources.

• Restructuring the share capital. It allows the company to reduce the number of shares in circulation, thereby increasing the relative value of the remaining shares. It can be used to buy back shares from a minority or non-strategic class, thus changing the shareholder structure.

• Flexibility in governance. By eliminating certain classes of shares, the company may simplify its governance structure or remove specific economic rights associated with those classes.

Repurchasing and then canceling classes of shares to maintain the company’s independence (case of an exiting shareholder)

When one of the shareholders (or associates) wishes to withdraw, the company may buy back his or her shares in order to cancel them, provided that certain legal and bylaw conditions are met. Such a repurchase notably requires that the shares be fully paid-up, that the company has sufficient reserves to finance the transaction, and that the bylaws or the general meeting of shareholders allow this kind of buyback.

In practical terms, the exiting shareholder offers his or her shares for sale; if the other shareholders do not wish (or are unable) to acquire them directly, the company can purchase them. Once the shares are bought back, they are generally canceled, leading to a reduction in share capital; the allocation of rights does not change for shareholders who keep their shares. This procedure allows shareholders who wish to maintain the stability of the company to retain their own shares, while ensuring an organized and equitable exit for the shareholder who wishes to sell.

The tax treatment of a share class repurchase

When a share repurchase is followed by its cancellation, the proceeds received by the shareholders are generally treated for tax purposes as proceeds from a share disposal, thereby avoiding the usual 15% withholding tax applied to dividends. This setup provides a considerable tax advantage: the shareholders concerned benefit from more favorable treatment than if they had received ordinary dividends.

However, the operation must be planned and carried out carefully. On the one hand, it is essential to respect the rights of all shareholders and to avoid prejudicing a share class without valid economic grounds. On the other hand, the reduction of the share capital resulting from the buyback may affect the company’s solvency and tarnish its image among investors and creditors if not managed properly.

Moreover, the buyback price must be fair, i.e., in line with the market value of the shares, to prevent disputes from dissatisfied shareholders or the tax authorities. Finally, if the repurchase is primarily intended to benefit from an unjustified tax advantage, it may be reclassified as an abuse of rights, canceling the tax benefits retroactively and exposing the parties involved to penalties.

Important point: Abuse of right in case of class repurchases

On June 4, 2024, the Luxembourg Administrative Court issued an important decision regarding a share repurchase involving share classes. In this case, two shareholders had split the share capital into 20 equivalent classes, then proceeded to repurchase and cancel two of these classes shortly thereafter.

The Court highlighted three main points:

1. Under the “inadequate path” criterion, the Court found that the structure was primarily created to convert dividends into capital gains, which benefited from a more favorable tax regime contrary to the intent of the law.

2. It found that there were no valid economic reasons to justify either the reclassification of the share capital or the immediate repurchase of the shares.

3. Finally, the Court ruled that the transaction was economically equivalent to a dividend distribution, reinforcing the notion of a misuse of tax rules.