Question: What’s the Difference Between Ordinary Shares and Preference Shares?Answer:
Your startup can secure funding by issuing ordinary shares and preference shares to investors.
An ordinary share gives the shareholder the right to vote on matters put before all of the shareholders of the company. The weight of a particular shareholder’s vote will usually depend on the ownership percentage that they have in the company. Typically, one share equals one vote. An ordinary share also provides the shareholder with the right to receive a share of the company’s profits by way of dividends.
It is at the business’ discretion whether or not it decides to pay dividends. Ordinary shareholders will only receive a dividend after the company has paid all its debts (including those to preference shareholders). The dividend amount an ordinary shareholder receives will fluctuate depending on the company’s performance.
As the name suggests, a preference share gives the shareholder preferred treatment over the ordinary shareholders, for instance:
- fixed dividend payments; and
- a priority right to be repaid if the company becomes insolvent (i.e. a liquidation preference).
The company sometimes pays dividends to a preference shareholder as a fixed percentage. Fixed dividends allow the preference shareholder to have more certainty over their investment as they receive their fixed dividend before the ordinary shareholders receive any dividend payment.
If a company can no longer pay its debts as and when they fall due (i.e. the company is insolvent), preference shareholders will have priority over the ordinary shareholders to recover their investment funds back.
This is a driver for investors wanting startups to issue preference shares rather than ordinary shares. They want assurance that the company will reimburse them before ordinary shareholders (which typically includes the founders).