Malcolm ZoppiWed Oct 11 2023
Preference Shares vs Ordinary Shares: Understanding the Key Differences
Preference shares, often termed ‘preferred stock’, are a form of investment that provides shareholders with preferential dividend rights, allowing them to receive dividends before ordinary shareholders.
Often referred to as ‘common stock’ or ‘equity shares’, ordinary shares represent part-ownership in a company. Shareholders have the right to vote on company matters and receive dividends, though they are the last to receive any repayment of capital if the company goes under. Moreover, the dividend payment for ordinary shares may fluctuate depending on the company’s profits.
- Ordinary Shares: Offer voting rights, potential for higher dividends, but come with higher risk.
- Preference Shares: Provide a safer investment, guaranteed dividends, but limited growth potential.
- Dividend Priority: Preference shareholders always come first.
- Voting Rights: Typically reserved for ordinary shareholders.
- Liquidation: Preference shareholders are prioritised.
- Types of Preference Shares: Cumulative and convertible are among the most common.
- Risk Assessment: Preference shares are generally safer, but ordinary shares offer higher growth potential.
The World of Preference Shares: An Overview
Preference shares, often termed ‘preferred stock’, are a form of investment that provides shareholders with preferential dividend rights, allowing them to receive dividends before ordinary shareholders. Furthermore, preference shareholders are usually first in line for capital repayment during liquidation.
Why Do Companies Issue Preference Shares?
Companies might issue preference shares to raise capital without diluting voting rights. It’s a way to secure funds without giving away more control. Additionally, preference shares are often more attractive to investors looking for a less risky form of investment compared to ordinary shares.
Issuing Shares: A Glimpse into Corporate Strategies
When a company decides to raise capital, it often issues shares to the public. The issuance of common stock, also known as ordinary share capital, allows investors to purchase a stake in the company. These common shares provide shareholders with voting rights and potential dividends, making them attractive to many.
However, not all shares are created equal. Some companies might issue preference shares to attract a specific group of investors, like the holder of the preference shares, who prioritise dividend payments and capital security. It’s crucial to understand the nuances between common shares and preference shares to make informed investment decisions.
Dividend Differences: Which Comes First?
When it comes to dividends, preference shareholders are at an advantage. They have the right to receive dividends before ordinary shareholders. If the company faces a tough financial year and cannot distribute dividends to all shareholders, preference shareholders still stand a chance to receive their share.
Voting Rights: A Crucial Distinction
While ordinary shareholders typically get voting rights, often one vote per share, preference shareholders might not. Voting rights for preference shareholders are usually limited to certain situations or are entirely non-existent, depending on the company’s articles of association.
Liquidation Privileges: Who Gets Paid First? Preference Shares vs Ordinary Shares
In the unfortunate event of a company’s liquidation, preference shareholders get paid before ordinary shareholders. This liquidation preference rights make preference shares a safer bet in volatile markets.
Types of Preference Shares: Which One Suits You?
There are various types of preference shares, including cumulative preference shares and convertible preference shares. The former ensures that if a company misses a dividend payment, it accumulates and is paid out later. The latter gives shareholders the option to convert their preferred shares into ordinary shares, potentially benefiting from capital growth.
How Do These Shares Differ in the Real World?
At a glance, preference and ordinary shares might seem similar. However, from dividend payments to voting rights and liquidation privileges, their features and benefits differ significantly. Understanding these distinctions can significantly impact one’s investment decisions.
What’s the Difference in Risk Levels In Share Capital?
Preference shares are often seen as a safer investment than ordinary shares. While they might offer lower potential for capital growth compared to ordinary shares, they come with a higher assurance of dividend payments and capital return in case of liquidation.
The Pros and Cons of Classes Of Shares
Like all investments, both preference and ordinary shares come with their set of pros and cons. Preference shares offer more security but might have limited growth potential. On the other hand, ordinary shares offer higher growth potential but come with a higher risk, especially in volatile markets.
Understanding the intricacies between preference and ordinary shares is pivotal for anyone venturing into the investment world. While preference shares provide a shield with their prioritised dividends and liquidation benefits, ordinary shares come with the allure of potentially higher returns and voting privileges.
Your choice between them should hinge on your financial goals, risk tolerance, and desired involvement in the company’s decisions. No investment is devoid of risks, but with comprehensive knowledge, you can optimise your decisions to align with your financial aspirations. As always, continuous learning and staying updated with market trends is the best strategy for any investor. Consult a corporate lawyer who can enhance your knowledge further on preference and ordinary shares.
Q: What is the difference between preference shares and ordinary shares?
A: Preference shares and ordinary shares are two different classes of shares that a company can issue. The main difference lies in the rights and privileges attached to them. Preference shares usually have a fixed dividend rate and are paid out before ordinary shareholders receive any dividends. Ordinary shares, on the other hand, do not have a fixed dividend and their dividend payments depend on the company’s profitability.
Q: What is the difference between preference and ordinary shareholders?
A: The main difference between preference and ordinary shareholders lies in the priority of dividend payment and voting rights. Preference shareholders have a higher priority in receiving dividends, usually at a fixed rate, before ordinary shareholders. However, preference shareholders typically do not have voting rights or have limited voting rights in the company. On the other hand, ordinary shareholders have voting rights in the company and their dividends depend on the company’s profitability.
Q: What are the types of preference shares?
A: There are various types of preference shares, including cumulative preference shares, non-cumulative preference shares, convertible preference shares, and redeemable preference shares. Cumulative preference shares entitle the holder to receive unpaid dividends in future years if the company does not declare dividends in a particular year. Non-cumulative preference shares do not have this feature. Convertible preference shares can be converted into ordinary shares based on certain conditions or at the discretion of the shareholder. Redeemable preference shares can be redeemed by the company at a future date.
Q: Do preference shareholders also receive dividends?
A: Yes, preference shareholders do receive dividends. In fact, they typically receive their dividends before ordinary shareholders. The dividend rate for preference shares is often fixed and stated as a specific amount per share or a percentage of the par value.
Q: Do ordinary shareholders have any voting rights?
A: Yes, ordinary shareholders have voting rights in the company. Each ordinary share typically carries one vote. This allows ordinary shareholders to participate in the decision-making process of the company, such as electing the board of directors or voting on important resolutions.
Q: Can preference shareholders convert their shares into ordinary shares?
A: Convertible preference shares give the shareholder the right to convert their preference shares into ordinary shares based on certain conditions or at the discretion of the shareholder. This conversion allows the preference shareholder to become an ordinary shareholder and enjoy the benefits associated with ordinary shares, including voting rights.
Q: Can preference and ordinary shares have different rights within the same company?
A: Yes, it is possible for a company to have different classes of preference shares and ordinary shares with different rights and privileges. Each class of shares can have its own set of dividend rights, voting rights, and other rights as set out in the company’s articles of association.
Q: What is the common type of preference share?
A: Cumulative preference shares are a common type of preference share. These shares entitle the holder to the payment of unpaid dividends in future years if the company fails to declare dividends in a particular year. This ensures that preference shareholders receive their dividends, even if the company faces temporary financial difficulties.
Q: How do shares differ from each other?
A: Shares differ from each other based on their characteristics such as dividend rights, voting rights, types of share capital, and priority in receiving dividends. Preference shares have a fixed dividend rate and are paid out before dividends are distributed to ordinary shareholders. They often do not have voting rights or have limited voting rights. On the other hand, ordinary shares have voting rights and their dividends depend on the company’s profitability.
Q: What is the difference between preference and ordinary shares in terms of dividend payments?
A: The difference lies in the priority of dividend payment. Preference shareholders have priority in receiving dividends and often receive dividends at a fixed rate. They receive their dividends before ordinary shareholders. On the other hand, the dividends of ordinary shareholders depend on the company’s profitability, and they receive their dividends after preference shareholders have been paid.
Find out more!
If you want to read more in this subject area, you might find some of our other blogs interesting:
- Advantages and disadvantages of buyback of shares
- Can I gift shares?
- What is a Share Purchase Agreement?
- Transfer shares to a spouse
- Do I Need a Lawyer for Buying a Business?
- Can a director be held personally liable for company debt?
- Cost to remove a director from a company?
- How to change a company name in the UK?
- When a company director resigns how long is a director liable?
Disclaimer: This document has been prepared for informational purposes only and should not be construed as legal or financial advice. You should always seek independent professional advice and not rely on the content of this document as every individual circumstance is unique. Additionally, this document is not intended to prejudge the legal, financial or tax position of any person.
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