Understanding on Ordinary Shares Vs Preference Shares

Shares generally have two types, which will be known as “Ordinary Shares” and “Preference Shares”. Ordinary shares and preference shares are distinguishing from each other based on their characteristics, benefits and rights that they offer to the holders of such shares.

Let’s examine the different rights and benefits attached to them.

Ordinary Shares

Ordinary Shares are the equity shares of the company. Sometimes, ordinary shares are also known as “Common Stock”.  Shareholders who have ordinary shares indicate that they have ownership in the company based on the portion amount of shares that they owned. For examples, if you have purchased 30 shares out of 100 shares of XYZ Company, it means that you have held 30% of stocks of the company or you have owned the company 30%.

Ordinary Shares carry voting rights. Shareholders have some privileges to get voting rights at the general meeting. They can appoint or remove the directors and auditors of the company. Each of the shareholders has rights to gain profits that earned by the company as well as to take the dividend.

Ordinary Shareholders have rights to receive dividends if the company makes profits. The dividend paid by the company is not fixed. Usually, when a company is just getting started, they do not pay the dividend and the entire money earned will be reinvested into the business for further development. Sometimes, the dividend will be paid to the shareholders only after all the payment of the liabilities had been paid. They are referred to as “residual owners”. They received what is left after all other claims on the company’s income and asset that have been settled. However, equity shareholders have no rights to get arrears dividend for previous years.

In the event of winding up of the company, the company must pay costs, wages, statutory contributions and taxes first followed by its creditors. Any capital that remains after paying the creditors will then allocated to the shareholders. Ordinary shareholders receive their share of capital after the preference shareholders are paid.

When it comes to redemption, ordinary shares cannot be redeemed by the company.  Ordinary shares are also cannot be converting into preference shares.

Preference Shares

Preference shares represent an ownership stake in a company, and sometimes it called preferred stock. Preference shares can have both equity and debt characteristics, which favoured by investors who have different priorities and interests to safeguards. Preference Shares have a priority claim over the company’s assets and earnings. The shares are more senior than common stock but more junior relative to bonds in terms of claim on assets.

Preference shareholders do not have voting rights on preference shares. However, they have rights to vote on the matters that directly affect their rights like a resolution of winding up of the company, or in the case of reduction of capital. Besides, shareholders of preference shares may have statutory powers to claim if the dividend remains unpaid for not more than 12 months from the due date of the profit or lesser.

Preference Shareholders enjoy priority first in the payment of profits and dividend. It promises the shareholders with a fixed dividend, both when the business is operating, and also in the event of a company entering into liquidation in the future. However, they are not paid first since the company needs to pay off the liabilities. But, they get paid off before the ordinary stockholders. While for the arrears of dividend, the shareholders will get arrears of dividend along with the present year’s dividend if it does not pay in the last previous year.

In the event of winding up of a company, preference shareholders are entitled to receive payment of capital after the claims of the company’s creditors have been paid, at the time of liquidation. In short, preference shareholders have preferential claims over dividend and repayment of capital as compared to equity shareholders.

Sometimes, some of the companies may issue redeemable preference shares on the condition that the company will repay the amount of share capital to the holders of this category of stocks after the fixed period or even earlier at the discretion of the company. The redemption must come from available profits of the company which would otherwise have been available for distribution of dividends or it must from the proceeds of a new issue of shares that made for redemption.

There is also a share called convertible preference shares. Convertible preference shares are preference shares which are issued with the right or option to convert to ordinary shares in the future, often at a pre-determined time frame and rate.

Basis Comparison

Ordinary Shares

Preference Shares 

Meaning Represent ownership of shareholders in the company Carry preferential rights on the payment of dividend and repayment of capital
Voting Rights Have voting rights No voting rights.

In exceptional circumstance, they have

Payment Dividend  Paid or may not be paid Receive dividend In a fixed rate
Arrears Dividend  Not Entitled Entitled
Repayment Of Capital Upon Winding Up Repaid at the end Repaid before equity shares
Redemption Not Entitled Entitled
Convertibility Non-Convertible Can be converted into ordinary shares

 Conclusion

Investors must understand the difference between ordinary shares and preference share. Investors should consider preferred stocks when they want a steady stream of income. The preferred stocks dividends pay a higher income stream than bonds. Although lower, the income is more stable than stock dividends. Therefore, investors should consider themselves which types of stock are suitable for them.

Written by Stella Goh | 14 February 2019

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Site last updated August 19, 2019 @ 6:52 am; This content last updated February 14, 2019 @ 9:06 am