Selling shares is an effective way to raise capital. Businesses interested in doing so must consider whether they want to issue ordinary shares or preference shares. There are many differences between ordinary shares and preference shares and each have their own benefits and risks.
What are ordinary shares?
Ordinary shares are shares issued that grant shareholders the right to vote in the business’s meetings. They are the most common type of shares issued by companies. The amount of ordinary shares a shareholder owns corresponds to their ownership percentage. The shareholder’s ownership percentage then determines the weight of their vote.
Ordinary shares give shareholders the right to obtain dividends. Dividends are a part of the business’ profit that is given to shareholders and is proportional to the number of shares they own. Each business decides whether they will or will not issue dividends to their shareholders. The amount typically depends on how well the business performs in the period.
Ordinary shareholders are granted dividends last. A business will usually pay their debts, and dividends to preference shareholders first. After this, if there are any dividends remaining they will be issued to the ordinary shareholders. As a result, there are more risks associated with dividend payments for ordinary shares as opposed to preference shares.
What are preference shares?
Preference shareholders allow shareholders to be given priority in certain aspects of the business. However, unlike ordinary shareholders, preference shareholders do not have voting rights.
As mentioned above, a company will pay preference shareholders their dividends before ordinary shareholders. These dividends payments are a fixed amount. Thus, dividend payments for preference shareholders have less risk as they are entitled to dividends first.
However, it is important to note that this does not mean that they will always receive a dividend each year. Whether they do or do not depends on the type of preference share they own. They can be either cumulative or non-cumulative. For shareholders with cumulative shares, if the business is unable to pay the dividend that year then they are still entitled to the dividend later on. On the other hand, for non-cumulative shares the shareholder is not entitled to receive it later on and loses the share.
What happens if the business becomes insolvent?
In the case of liquidation, preference shareholders are entitled to the repayment of their investment before ordinary shareholders.