Companies may issue different classes of the same type of shares (e.g. 'A' ordinary shares and 'B' ordinary shares) or different types of shares (e.g. ordinary shares or preference shares). Different rights can be attached to different classes and types of shares for various purposes such as:
- to distinguish voting rights in a company;
- to prioritize distribution of dividends and assets of a company;
- to issue shares to raise funds with debt features;
- to cater to investors who only want to invest for a specific term by issuing shares which can be redeemed in the future, allowing the investor to exit.
Let's examine the two common types of shares issued by companies and the different rights that could be attached to them.
Comparison between Ordinary Shares and Preference Shares
| Ordinary Shares | Preference Shares | |
| General | Most common type of shares issued. They are generally regarded as equity investments. | By definition, a preference share is a share by whatever name called, which does not entitle the holder to a right to vote or to participate beyond a specific amount in distribution of dividend, redemption or winding up.Preference shares can have both equity and debt characteristics, favoured by investors who have different priorities and interests to safeguard. |
| Uses/Holders | Suitable for parties that wish to exert some control (voting), participate in earnings (dividends) and growth (capital) of the company. | Preference shares are a
useful investment tool for parties with the following objectives
& requirements:
|
| Memorandum or articles | The terms of issue of shares need not be expressly set out in the company's articles, unless different 'classes' of ordinary shares are to be created. For example, 'Class A' ordinary shares, 'Class B' ordinary shares, can be specified in the articles to create small differences between the classes. This includes allowing different dividends entitlements to each share class, or where different are to rules apply for 'vesting', share transfers, or exit valuation, etc. | The law requires that
rights of preference shares must be expressly set out in memorandum
or articles. Apart from rights expressly given in a memorandum or
articles, preference shareholders have no other additional rights.A
company may not allot any preference shares or convert any issued
shares into preference shares unless there is set out in its
memorandum or articles the rights of the holders of those shares
with respect to:
|
| Voting Rights | Ordinary shares by default confer on the shareholder full voting rights that enable the shareholder to participate in the decision-making process of a company.A different class of ordinary shares may be created in the articles to confer 'weighted votes' for specific matters, giving the class of shareholders additional votes over the other ordinary shares. | The articles of the
company must either provide voting rights or expressly provide no
voting rights on preference shares.Generally, preference
shareholders are often not given voting rights, but have
preferential rights in respect of its entitlement to dividends and
have priority in being paid first compared to ordinary
shareholders. Notwithstanding that the articles of the company may not provide for voting rights for preference shares, preference shareholders have the statutory right to vote in 3 situations:
|
| Payment of Dividend | Ordinary shareholders receive their dividends after preference shareholders are paid. | Preference shareholders receive their dividends first in priority to ordinary shareholders. |
| Rate of Dividend | Dividends for ordinary shares are not fixed. The rate of the dividend is determined by the board of directors. The board will resolve whether or not there are available profits to enable dividends to be paid to the shareholders. There is no obligation on the directors to recommend a declaration of dividends at a general meeting. | The articles of the company may confer on preferential shareholders the right to a fixed amount or rate of dividend, subject to the availability of profits of the company.Alternatively, the articles may confer on preferential shareholders the right to receive the same rate of dividends as ordinary shares but in priority to the ordinary shares. |
| Cumulative | Ordinary shares have no right to an accumulation of dividends from previous years. | The articles may confer
on preference shares a cumulative right to dividends which entitles
the preferential shareholder to accumulate unpaid dividends of the
previous years.E.g. If the company did not declare dividends in
year 2015 due to unavailable profits, the preferential shareholder
will be owed the dividend for 2015 in the following year 2016 and
paid when the company has sufficient profits. In contrast, for non-cumulative preference shares, there is no right to an accumulation of dividends from previous years when dividends were unpaid. All accumulated dividends must be paid to preference shareholders before any dividend for ordinary shareholders is declared. |
| Repayment of capital upon winding up of company | Upon the winding up of a company, the company must pay costs, wages, statutory contributions and taxes first followed by its creditors. Any capital that remains after paying the creditors is then allocated to the shareholders. Ordinary shareholders receive their share of the capital after preference shareholders are paid. | Preference shareholders are entitled to receive repayment of capital after creditors of the company have been paid, and in priority to ordinary shareholders. |
| Participation in surplus profits upon winding up of company | Ordinary shareholders are entitled to participate in the surplus profits or assets of the company which remain after repayment of capital. | Preference shareholders have no right to participate in surplus profits unless the right to participate in surplus profits is expressly set out in the articles. |
| Redemption | Ordinary shares cannot be redeemed by the company.Ordinary shares also cannot be repurchased by the company (save for a public company authorized by its articles). | Redeemable preference
shares ("RPS") are a type of preference
shares that are issued on terms that they may be redeemed in the
future at the company's option or subject to the terms of
issue. It is considered to a hybrid of debt and equity depending on
its exact terms, and can be issued for short term access to capital
from investors.The issuance of RPS must be authorised by the
articles of the company and the redemption can be effected only on
the terms and in such manner as provided by the articles.The
redemption must come from:
|
| Convertibility | Ordinary shares are non-convertible to a different class of shares. | Convertible preference shares are preference shares which are issued with the right or option to convert to ordinary shares in the future, often at a pre-determined time frame and rate. |
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
