Limited companies use shares to distribute ownership between shareholders. Early Stage companies or lifestyle business with a very simple ownership structure typically only issue shares to their directors. However, once investors or other parties come on board, the ownership structure of a company becomes more complicated, with different shareholders having different access to dividends and voting rights
The two main classes of shares that are issued by most companies are Ordinary Shares and Preference Shares.
Ordinary Shares, also known as common stock, are the “default” share class that is normally issued when a company is incorporated. Ordinary shares give their holders voting rights, as well as the rights to take dividends from the company’s profits.
Voting rights guarantee holders that they have a say on key business decisions for the company, these are proportioned to how many shares one holds. Decisions are typically taken by majority, depending on a company’s articles of incorporation.
Although common stock grants the right to take dividends when these are paid, the company is not obliged to distribute them. A contrary decision could be taken for several reasons, including underperforming profits, a decision to reinvest profits in growth or any other strategic choice.
Preference shares come with no voting rights. However, their advantage over Ordinary ones is that Preference shareholders are first in line when it comes to dividend payments. Not only that: in the event of a future liquidation or sale Preference shareholders are also the first ones to get paid.
Moreover, dividend payments for Preference shareholders are usually agreed in advance, both in terms of amount and frequency of payment. For this reason, Preference shares are usually regarded as a less risky investment compared to Ordinary or other classes of shares. However, this also means that the dividends paid to Preference shareholders might not match a growth in the company’s profits, but many investors see this as the necessary evil to balance the certainty that comes with this class of shares.
It must be noted, however, that Preference shares do NOT guarantee the payment of dividends in 100% of cases. The company might still decide not to pay dividends at all, should the circumstances require it.
Another caveat of Preference Shares that has to do with dividends is that there are two main types of Preference Shares:
- Cumulative: cumulative preference shareholders benefit from the certainty of being paid all the dividends at some point in the future. If a dividend payment is missed, it’s rolled over to the next dividend date until dividends are issued.
- Non-cumulative: if the Preference Shares are non-cumulative, their holders will just lose the dividends when the company decides not to pay them, which means a higher degree of uncertainty for the investor.