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In the context of a private company limited by shares, you may have come across the phrase ‘classes of interest.’ Within a private company limited by shares, you may have several shareholders who have each invested different amounts of capital into the company. In return for their investment, the company may issue these investors with the same class of shares, or each shareholder may have different classes of shares, each class containing different rights. In this sense, classes of interest refer to the different levels of shareholder rights within a company. This article will outline:
- different classes of shares within a limited liability company; and
- types of shares in a company, with a focus on ordinary shares.
Different Classes of Shares
After a company gains the consent of its current shareholders, it can create infinite classes of shares. These classes of shares are typically alphabetised and often contain varied rights to suit a specific company structure.
For example, the High Court has dealt with the allocation of shares for an improper purpose. In this case, the company in question had three distinct share classes:
- class A gave unlimited voting rights to the managing director;
- class B gave full voting rights to the director’s spouse upon the director’s death; and
- class C gave no voting rights but a right to share in the profits.
From the example, classes of interests can contain unique rights and obligations as specified in a company constitution. However, these classes generally impact a shareholder’s:
- entitlement to vote;
- participation in dividends; and
- participation in the winding up of a company.
We explore each of these rights below.
Entitlement to Vote
Generally, shareholders receive ordinary shares unless otherwise stated. Ordinary shares carry one vote per share. This means that in shareholder meetings, your ability to influence the outcome of the resolution generally depends on how many shares you have in the company. The more shares you hold out of the total amount of shares on issue means you will have more voting power when it comes to shareholder matters.
For example, suppose there are a total of 100,000 ordinary shares on issue in the company. If you hold 75,000 shares, you own 75% of the company. In this case, depending on the company’s constitution and shareholders agreement, you may pass a shareholder decision that requires approval of shareholders holding at least 75% of the shares in the company by yourself.
Alternatively, the company might create a new class of shares that entitles the holder of that class of shares to two votes per share held. Accordingly, the shareholder’s voting power is vastly increased.
Entitlement to Dividends
A company can distribute its profits to its shareholders in the form of dividends. An ordinary share will entitle you to any dividends declared on ordinary class shares. However, this can vary with a preferential share, where shareholders will be paid a fixed amount before other share classes. The priorities for dividend payment can affect which shareholders do and do not get dividends at a given time.
For example, the directors of the company can declare a dividend on certain classes of shares and not others. Where a company has ordinary class shares and Class A shares on issue, the directors can declare a dividend to only holders of ordinary class shares. However, where a dividend is declared on a class of shares, all holders of that class of shares must receive the dividend.
Entitlement to Capital Upon Winding up the Company
When you wind up a company, the directors or a liquidator will sell all business assets and subsequently use the proceeds to pay off the company’s debts in order of priority. Once all debts have been repaid, there may be assets (i.e. cash) left over. Accordingly, the liquidator will distribute any leftover funds to shareholders. Again, different classes of share may have different rights to capital distribution.
Different Types of Shares
There are various types of shares that a company can issue, including ordinary class and preference shares. However, as mentioned, a company can create an infinite variety of share classes with different combinations of entitlements to suit their company structure. Nevertheless, we consider the entitlements attached to ordinary class shares, preference shares and different classes of shares with various combinations of rights attached to them.
Ordinary Class Shares
The most common type of shares in private companies are ordinary class shares. Ordinary class shares carry one vote per share. So, if you own fifty ordinary shares in the company, you can advance fifty votes in a shareholder meeting. In addition to voting rights, ordinary class shares also allow you to attend a company’s general meetings.
Ordinary class shares also entitle its shareholders to participate in company dividends. Of course, the dividend amount that an ordinary shareholder receives will depend on the company’s profits. Additionally, ordinary shareholders will only receive a dividend payment after the company pays off any dividends to preference class shareholders first. Therefore, the amount of dividends you receive may not be in proportion to your shareholdings due to the existence of classes of shares.
Preference Shares
Preference shareholders are generally entitled to the same rights as ordinary shareholders, including rights to:
- attend and vote in general meetings;
- participate in the winding up of the company; and
- participate in company dividends.
However, preference shares differ from ordinary shares in that preferential shareholders typically receive dividends before other shareholders. Additionally, if the company is wound up, the directors or a liquidator must allocate the proceeds to preference shareholders before the other classes of shareholders.
An Example
Where the company has enough funds on liquidation, preference class shares typically allow for each preference class shareholder to receive the full amount they initially invested. This class of shares is highly favoured amongst venture capitalists and institutional investors.
Suppose Investor A paid $200,000 to receive 200,000 preference shares, and Investor B paid $100,000 to receive 100,000 preference shares.
After paying creditors, the company has $300,000. Accordingly, Investor A and Investor B will be entitled to receive each of their initial investment sums before any other shareholder holding a different class of shares.
Where the company does not have enough to return Investor A and Investor B’s initial investment sums, these two investors will typically be entitled to an amount proportionate to their initial investment after adding their investment together.
Where the company only has $150,000 after paying creditors, Investor A will receive $100,000 (as they hold 66.66% of the total investment sum on preference shares). Investor B will receive $50,000 (as they hold 33.33% of the total investment sum on preference shares).
This guide will help you to understand your corporate governance responsibilities, including the decision-making processes.
Various Combinations
With the written approval of its existing shareholders, company directors can create and issue a new class of shares. The new class of shares and the rights attaching to the shares will be within the company’s constitution. A company must amend its constitution if directors wish to create a new class of shares.
Additionally, a company can create a new class of shares with extra rights or restricted rights. For example, you can create preference shares which generally attract the following enhanced rights, amongst others:
- priority to receive dividends over all other classes of shares;
- priority to receive the amount paid on the shares upon winding up of the company; and
- anti-dilution rights.
The company can also create a new class of shares with restricted rights, such as:
- no right to vote at shareholder meetings;
- right to receive dividends;
- right to receive surplus assets upon winding up of the company; or
- any combination of the above, amongst others.
Key Takeaways
Classes of interest within a corporation refer to the different rights a shareholder has within a company. Depending on what class of share you own in a company, this will affect your:
- ability to vote in shareholder meetings;
- entitlement to dividends (if any); and
- priority to capital in the event that the company is wound up.
If you need help understanding classes of interest and various classes of shares within a company, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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