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If you are a business owner or an investor, understanding the difference between preference and ordinary shares is important. While both type of shares represent part-ownership of a company, there are some significant differences in terms of the rights that come with each class.
When a limited company is incorporated, the first members are usually the founders of the company, who are issued ordinary shares in proportion to their ownership rights. Ordinary shares are the most common type of share class and are typically issued to founders, employees and investors claiming SEIS or EIS relief.
Ordinary shares come with certain rights, such as voting rights at company meetings. Shareholders of ordinary shares also have the right to receive dividends if the company is profitable and the directors decide to pay the profits to shareholders rather than reinvest the cash in the business.
However, ordinary share ownership can be risky as investors stand to lose their initial investment if the company fails. In case of liquidation, ordinary shareholders are the last to receive payment after all outstanding debts and preference shares are paid.
As a company grows and needs additional investment, it may issue preference shares. Preference shares are different from ordinary shares in that their owners are given certain preferred rights compared to ordinary shareholders. The rights attached to preference shares are set out in the company’s articles of association.
Preference shares often come with liquidation preference rights and preferential dividend rights. Liquidation preference rights entitle the holder of the preference shares to be paid out ahead of the holders of the ordinary shares on liquidation. Preferential dividend rights allow the holders of the preference shares to receive a preferential dividend ahead of ordinary shareholders.
Companies that want to raise more capital to finance their business often issue preference shares, especially during a funding round. This allows the owners to get cash without losing control of the company.
If you intend to issue shares or alter the shareholding in a business, it is important that it is clearly documented in your shareholders agreement, articles of association and other important documents.
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