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An important part of setting up a company involves the directors allocating shares to their shareholders. These shares can be split into different classes types, so that different rights can be given to different shareholders. Why do this? One very good reason is that a company’s owners and directors might want different shareholders to contribute or share in different parts of a company.
Below are some pretty common classes of shares and what rights you’d generally expect for them.
1. Ordinary Shares (also known as ‘Common Stock’)
These are the pop songs of radio - the most commonly issued types of shares. The rights that are generally attached to ordinary shares are:
- Dividend rights
- Right to receive notices of, attend and vote at meeting of members
- Right to payment of the amount paid per share should the company wind up (or a pro-rata amount if there’s not enough to go around) and the right to participate in the surplus assets or profits of the company.
Ordinary shares can be divided into different types, with slightly different rights attaching to each (such as A Ordinary Shares, B Ordinary Shares etc). For example, type ‘A’ ordinary shares might pay higher dividends (yay!) or have stricter share transfer rules (nay!), than type ‘B’ ordinary shares.
A company can also change the nominal value of a share (the amount a shareholder has to pay to “buy in” to the company) which can have the effect of changing how much voting power shareholders have. Normally, one share has one vote - but where type ‘A’ ordinary shares cost $1, and type ‘B’ shares cost 10 cents, the holders of type ‘B’ shares have more voting powers for each $1 they put in.
2. Preference Shares
Preference shares have the same rights as ordinary shares, however holders of preference shares get priority when repayments of capital and dividends are being handed out - some will even have fixed dividend amounts. Preference shares normally don’t have voting rights.
Preference shares can be really useful when companies, especially start ups, want to raise money from outside investors. Issuing preference shares can work like a loan, but doesn’t appear as a debt on the company’s books - the company gets an inflow of cash and their outside investors will normally get repaid their initial investment amount (plus a return maybe) from the company’s profits as preference dividends.
Here are some types of preference shares:
2A. Redeemable Preference Shares
Redeemable Preference Shares can be bought back by the company for cash - this buy-back can either happen after a particular date (a ‘vesting period’), based on some event (e.g. liquidation event or an IPO) or at any time at the option of the company or the shareholder.
2B. Cumulative / Non-Cumulative Preference Shares
Cumulative Preference Shares are pretty similar to Redeemable Preference Shares, however where a company hasn’t made enough profit in one year to pay out its Cumulative Preference Shareholders, its dividends for that year and going forward will pile up until all Cumulative Preference Shareholders are paid. Ordinary shareholders will not receive dividends until Cumulative Preference Shareholders get their dividends (including any dividends owed from previous years).
Non-cumulative Preference Shares don’t have any rights to claim dividends - if a company chooses not to declare a dividend for a year, then too bad so sad for the holders of these classes of shares.
2C. Participating Preference Shares
This is a term that is more usually used in the US, but the idea is that Participating Preference Shareholders get a predetermined preference dividend (say a certain % or up to $X amount), plus they also get a cut of remaining dividends or any surplus assets that would be received by ordinary shareholders.
2D. Convertible Preference Shares
Convertible Preference Shares can be converted by the shareholder into a certain number of ordinary shares - either after a particular date or after a particular event happens. Whether the holder of those shares will want to do that is another question, and will depend on how valuable the common shares are vs the preference shares.
The cool thing about preference shares is that you can chop and change the rights that are given to those shares as the company needs or wants.
3. Founder’s Shares
As the name suggests, these shares are issued to (you guessed it) the founders of a company. They act like ordinary shares, but tend to have the following special incentives:
- The shares vest (can be sold) immediately or have accelerated vesting (quicker than maybe some other kinds of shares)
- The shares have very low par (upfront) value
- Can retain rights to vote on specific matters