Limited companies, whether public or private, can issue shares of different classes. These shares represent part-ownership of the company and are normally issued in return for cash (known in this context as capital). To start off, the difference between preference vs ordinary shares really boils down to who you are issuing the shares to.
Ordinary shares are the most common type of share class and are usually issued to people like the original founders, employees and investors claiming SEIS or EIS relief. Companies often introduce preference shares which are issued to certain external investors like venture capital funds.
In this article, we take a high-level look at preference vs ordinary shares and examine the material differences between these two share classes.
What are ordinary shares?
When you incorporate a limited company, the first members will normally be the founders of the company who are usually issued with shares in proportion to their agreed ownership rights. For example, if two individuals decide to start a company on equal footing, they’ll be given a number of ordinary shares on a 50/50 basis. These ordinary shares are issued at a nominal value per share, often £1.
Ordinary shares will have certain rights including the right for the owners to vote at company meetings and distribution rights. The owners also have the right to receive dividends if the company’s profitable and the directors decide to pay the profits to shareholders rather than re-invest the cash in the business.
Ordinary share ownership, as a form of investment, is relatively risky as if the company doesn’t succeed, investors stand to lose their initial investment. On liquidation, ordinary shareholders are the last to get paid after all outstanding debts and the payment of any preference to the holders of the preference shares.
What are preference shares?
Some companies issue preference shares in addition to ordinary shares, typically once they start to grow and need additional investment. Preference shares are different from ordinary shares, in that their owners are given certain ‘preferred’ rights compared to the ordinary shares. The rights attaching to the shares in the company will be set out in the company’s articles of association. There are no set requirements as to what preferences are attached to the preference shares, but we have set out the more common preferential rights below.
Preference shares often have the following rights:
Liquidation preference rights
Liquidation preference rights entitles the holder of the preference shares to be paid out ahead of the holders of the ordinary shares on a liquidation. Liquidation preferences can be structured as participating or non-participating.
A participating liquidation preference entitles the holder of the preference share to receive back the amount paid for the preference share, following which they receive a further distribution alongside the holders of the ordinary shares on a pro rata basis.
A non-participating liquidation preference entitles the holder of the preference share to receive the amount paid for the preference share ahead of the holders of the ordinary shares only. Any further amount available for distribution is allocated to the holders of the ordinary shares only.
Preferential dividend rights
Preferential dividend rights allow the holders of the preference shares to receive a preferential dividend in priority to the holders of the ordinary shares. The right to receive a dividend will always to be subject to the company having sufficient distributable profits.
Who issues preference shares?
Preference shares are usually issued by companies whose owners are looking to raise additional capital to finance their business, often as part of a funding round. Issuing preference shares gives founders the ability to get cash without giving up control of the company. This only works if the preference shares are non-voting.
Who invests in preference shares?
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