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Private companies: s172(1) statements and dividends

Stephanie Henshaw outlines a structure to help private companies approach their s172(1) statement and Simon Kettlewell highlights ICAEW's guide on paying dividends.

All large companies are now required to include in their strategic report a statement explaining S172 reportinghow the directors have complied with their duties under section 172 of the Companies Act 2006 (a s172(1) statement). Listed companies tend to have systems in place for preparing complicated narrative reports. However, private companies without the same resource or experience have found the new statement much more challenging. 

The purpose of this article is to suggest a structured approach to make the process easier and the statement itself more effective in communicating the board’s key decisions. 

The requirement

First, let’s deal with the statutory obligation, contained in s414CZA of the Companies Act. Essentially, the statement must explain how the directors have had regard to six factors when performing their duty under section 172, being:

  • the likely consequences of decisions in the long term;
  • the interests of employees;
  • business relations with customers, suppliers, etc;
  • the impact of the business on the community and environment;
  • the reputation for a high standard of business conduct; and
  • acting fairly between members. 

A good s172(1) statement does not quote the legal requirements or deal only in generalities. Instead, it reflects the company: its strategy, decision-making and communication. It is relevant, focused and consistent with the rest of the annual report. 

The approach

How can private companies create a statement that ticks those boxes? One way to approach it is to work through the steps below. 

1 Identify who your stakeholders are

Obvious stakeholders are the company’s members or investors, but they also encompass lenders, customers, suppliers and employees, among others. For a property rental business, for example, tenants may be included. With the increased focus on sustainability, those affected by, or benefiting from, the company’s environmental activities may also be included, particularly if the company presents itself as having ‘green’ or ‘sustainable’ credentials. A company’s impact on ‘the community’ is not simply a form of Corporate Social Responsibility reporting. If the business interfaces with lots of local businesses or is a significant local employer, it could have real commercial focus. 

2 Consider how you engage with those stakeholders

For a wholly owner-managed business, members may be involved on a day-to-day basis with practical operational decisions in their capacity as directors. But for other large private companies, interaction might be more formal, via a general meeting. Engagement with employees might be through a regular programme of surveys, staff meetings, business update presentations or an employee committee that liaises with the board. Engagement with other stakeholders might be more dependent on how individual relationships are managed. For example, many companies will have regular communication with their lenders, including presenting management accounts or submitting confirmations of covenant compliance. 

3 Pinpoint what your key business decisions were during the year

In the face of COVID-19, key decisions may have related to whether to seek additional finance via a government support scheme, or whether to offer temporary rent concessions. For companies that Brexit has had an impact on, key decisions may relate to securing supply lines or establishing a place of business in a new jurisdiction. Key decisions might also include not taking an action: for example, suspending planned capital investment or not paying a dividend to protect the business’ cash flow position. 

4 Make the link

Link the key decisions to the relevant stakeholders and explain how the company’s engagement with the stakeholder had an impact on the decision. For example, furlough might be a key decision. Explain how the furlough process was implemented, such as by holding discussions with employees to identify which functions needed to be maintained and who would be furloughed. 

Finally, think about how your s172(1) statement relates to the rest of your narrative reporting – is it consistent with the Review of Business, for example? Companies with more than 250 employees must include a section on employee engagement in their directors’ reports. If a key decision relates to employees, consider cross referencing between the s172(1) statement and the employee engagement disclosure to link the two and minimise repetition. 

Presentation and audit

The legislation does not prescribe how to present a s172(1) statement, so consider how to make the analysis clear and engaging. While some companies prefer a simple narrative statement, using bullet points and sub-headings, others use an introductory narrative to set the scene, identifying stakeholders and outlining the engagement process, followed by a table to explain the key decisions and how they were mediated. 

Auditors are required to report on whether the company has complied with legislation on narrative reporting and whether the information is consistent with their knowledge derived from the audit. Discussing your proposed s172(1) statement with your auditor at an early stage in the audit process will minimise the risk of problems later on. 

Thinking ahead

Some private companies found their first s172(1) statement challenging because of its unfamiliarity and because it took time to identify relevant information. Unlike listed companies, many large private companies don’t have a formal structure to their board minutes to record how decisions were made and how different section 172 elements were addressed. The company’s s172(1) statement can’t simply be rolled forward from year to year: it must reflect the key business decisions specific to each year and these will inevitably change. To make the process less onerous in future, it is worth considering how you can capture key decisions in board minutes and record your engagement processes at the time so that the building blocks for your statement are already in place at the year end. 

About the author
Stephanie Henshaw
, Partner, PKF Francis Clark

Paying dividends – the essentials

The legislation surrounding dividends is complex and the potential for mistakes here is high, particularly for directors of smaller companies.  A new ICAEW guide, Paying Dividends – the Essentials, was drafted with small company directors in mind. It provides a reminder of some of the key issues regarding the payment of dividends. The following are two particular questions raised in the guide.

Has the financial position deteriorated since the accounts were prepared?

Directors looking to propose a dividend need to assess whether the company has sufficient distributable profits. Due to the pandemic (as well as the common law on capital maintenance), it is not appropriate to simply assume that all distributable profits in existence at the previous year end are still available. Losses may have arisen subsequently, reducing distributable profits recognised in those previous financial statements. Directors must ensure they have an up-to-date view on the company’s financial position before proposing a dividend. 

Should the company pay dividends even if it has profits available to do so?

Before proposing (and paying) a dividend, directors need to consider whether, after making the payment of the proposed dividend, the company will have sufficient funds to settle its debts as they fall due. 

Even if the company has available profits and sufficient cash to pay a dividend, directors should consider how COVID-19 measures have affected this. It could be the case that the pandemic has not had a negative impact on profitability, and due to the receipt of furlough monies, rates relief and other grants, the company may have seen an increase in the level of cash held. Directors should carefully consider the appropriateness of extracting profits by way of dividends where these are effectively funded by government support.

About the author
Simon Kettlewell
, Director, HAT Group of Accountants

By All Accounts July 2021

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