Sam Thewlis explains the difference between ordinary and preference shares.
In the UK, most limited companies are 'limited' with reference to their share capital, although may instead be limited by guarantee.
A company may have just one type of share, which will normally be 'ordinary shares', but may also have other classifications of shares, some of which are explored below.
Ordinary shares
UK companies limited by shares will have ordinary shares as these not only define the limited liability of shareholders, but will also direct where any assets will be distributed on the winding up of a company.
In simple terms, if you have paid £1 for a share with a nominal value of £1, then that share is said to be fully paid-up, and, as a shareholder, you have no further liability in the event of a company winding up. Shares may be issued as partly paid, and should the company be wound up whilst partly paid shares are in issue, the remaining amount of the nominal value of the shares may be called from the shareholders. Note that the nominal value of the share, i.e. a £1 share, is different and often very different in monetary terms from its market value.
A company will have authorised and allotted (or issued) share capital. A company's governing documents may authorise it to issue 100,000 shares, but it may only issue 100. Or 10. Or 1. The proportion of shares held in comparison to those issued equates to any given shareholder's percentage holding in the company, i.e. a shareholder owning 1 out of 10 shares will own 10%; a shareholder owning 1 out of 100 shares will own 1%.
A company may issue additional shares that fall within its authorised limits at any time. However, it can't issue new shares below their nominal value. If it wishes to extend the number of authorised shares, it may normally do so by means of a company resolution. However, given the examples above, it is easy to see why the issue of new shares would dilute the holdings of existing shareholders without any preventative rules. Take our shareholder who owns 10%, being 1 share out of 10. If the company then issues a further 90 shares, our shareholder's percentage holding would fall from 10% to 1% in one fell swoop.
To combat this inequitable situation, companies are normally bound by pre-emption rights, which means the company must offer any newly issued shares to existing shareholders in proportion to their existing holding. Our shareholder then would therefore be given an option to purchase nine additional shares before they are offered to anyone else, thereby allowing him to maintain his 10% holding following the new share issue. In practice, as such options are known as rights issues.
However, rights issues are used by companies as a way of raising equity funds, so the new shares must be purchased by the existing shareholders at a price normally set by the company with reference to the market value. Where shares are issued to shareholders without requiring additional investment, this is known as a bonus issue.
Public limited companies, Plcs, must have an allotted minimum nominal share capital of £50,000 or €65,600, but not a mix of both currencies, or in any other currency. Shares must be at least 25% paid up.
Companies may have more than one class of ordinary share, for example 'A' ordinary shares and 'B' ordinary shares. The reason for this is that different classes of share will have different right attaching to the shares. 'A' shares may be entitled to a dividend and 'B' shares may not. 'B' shares may carry the right to vote at shareholders' meetings and 'A' shares may not. Each different class of ordinary share will have a different market value depending on valuable the market considers the rights attaching to each particular class -- a share with no entitlement to dividend, rights on winding up or entitlement to vote is unlikely to be worth a fat lot.
Preference shares
Preference shares have some kind of preference over ordinary shares, normally in relation to the payment of dividends. As there are restrictions on which funds a company may use to pay dividends, it may be that there are not sufficient funds to pay full dividends on both ordinary and preference shares. In this case the preference shares must be paid before the ordinary shareholders may receive any dividend. Preference shares are often set at a fixed coupon rate, and those that were issued some time ago, may have a rate e.g. 7.5% that compares favourably with today's high street banking rates.
Preference shares may be cumulative, i.e. if a dividend is not paid in one year, a double dividend is due the following year. Preference shares may also be participating, i.e. they may be entitled to a fixed proportion of the company's assets on a winding up.
Redeemable shares
Companies may also issue redeemable shares, although it may not issue only redeemable shares. As the name suggests, these shares may be bought back by the company at a future point. Companies will be especially keen to redeem shares if, for example, they are preference shares with a high coupon rate.
All the above types of share generate 'equity' funding, which is money that has been invested in the company, as opposed to 'debt' which comprises funds loaned to the company, which will need repaying at a future date and servicing with interest payments. However, there may be some among you who would argue that preference shares with fixed coupons and redeemable shares also show characteristics of debt, rather than equity finance, and you would be right...
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