When Dividend Payments Can and Must be Made
If shareholders wish to draw funds from the company and if the company has distributable profits, dividends can be paid. As a private company, you are not normally under any obligation to pay dividends (subject to any arrangements with capital investors or preference shareholders) but if you do not shareholders may be unwilling to wait until the company is sold before they receive any economic benefit.
The choice is whether surplus resources can be used more beneficially and efficiently by the company or whether they should be released to the shareholders who may be in need of immediate resources and can perhaps, make better use of them in the light of the company's record in producing a return on capital.
When Dividends Can & Must be Paid
As to when dividends can be paid, the Board of directors decides how much is to be paid to shareholders in any accounting period and accordingly declares the dividend. You can pay dividends at anytime, but it is usual to wait until the financial year's results are known before declaring a dividend. Interim dividends paid are set against the year's distributable profit.
In declaring dividends you must take account of the cash needed for continuing working capital requirements of the company and you can only pay a dividend out of distributable profit i.e. revenue profit and realised capital gains. Reserves of undistributed profit from earlier years may be carried forward, as may any deficit, in order to determine the amount of distributable profit available at any time.
Ordinary Shareholders: Have no right to require dividends to be paid. They would normally however expect that their economic interest in the company will lead to capital growth (the increase in value of their shares), and dividend income (the distribution of surplus cash generated by profits). It is however, common in joint venture companies to stipulate in the shareholders' agreement and/or the Articles of Association a minimum dividend (e.g.10% of profits after tax) which has to be distributed. Where controlling shareholders refuse to distribute profits and thereby deprive the minority of income the minority may be able to commence an action for unfair prejudice.
The Preference Shareholder: The rights attached to preference shares will normally be defined in the Articles of Association including the right to receive dividends at a fixed rate payable on specific dates. It is important to compare the cost to your company of dividends payable to any preference shareholder with the cost of other sums advanced to the business, e.g. a bank loan. For example, with a fall in interest rates, it may be that the dividend originally agreed on the preference shares becomes unduly high. In that event some reorganisation, possibly involving redemption or repurchase of your preference shares, may be advisable.