Share Classes in Australia: Types and Implication

In Short

• Understanding Share Classes: Australian companies can issue various share classes, each with unique rights and obligations, influencing corporate control, investment strategies, and employee incentives.

• Common Share Types: The primary share classes include ordinary shares, preference shares, redeemable preference shares, and performance shares, each serving different purposes within a company’s structure.

• Strategic Importance: Selecting appropriate share classes is crucial for aligning with company goals, attracting investors, and motivating employees effectively.

Tips for Businesses

Carefully consider the rights and obligations attached to each share class before issuing them. Align your share structure with your company’s strategic objectives, ensuring it appeals to potential investors and serves as an effective tool for employee motivation. Regularly review and adjust your share classes to meet evolving business needs and growth plans.

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Table of Contents

• Common Share Classes
• Ordinary Shares
• Preference Shares
• Redeemable Preference Shares
• Performance Shares
• Key Takeaways
• Frequently Asked Questions

Your company issues different categories of shares, with each class carrying a distinct set of rights, characteristics, and obligations. In other words, the rights and restrictions attached to the shares in one class distinguish it from other classes of shares in a given company. In Australia, as a matter of corporation law, particularly under the Corporations Act 2001 (Cth) (Corporations Act), proprietary limited companies and public companies limited by shares must issue at least one share and have at least one shareholder; however, there is significant flexibility in what class(es) of shares you issue. Share classes are fundamental in company structures for several key reasons, including:

• how you organise corporate control;
• ensure investment flexibility; and 
• offer employee incentives. 

Accordingly, it is important for you to understand the different classes of shares and their consequences so that your company can issue the right class of shares to the right people, especially as the company grows. This article seeks to explain the common types of share classes in Australia and their implications for your company.

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Common Share Classes

This article will cover the following four common classes of shares:

• ordinary shares;
• preference shares;
• redeemable preference shares; and
• performance shares.

Ordinary Shares

The most common class of shares in Australia are ‘ordinary’ shares. Shareholders with ordinary shares generally have the right to:

• attend shareholder meetings and vote on fundamental issues including, but not limited to, changing the company’s name and adopting or amending the company’s constitution;
• receive declared dividends and other distributions; and
• participate in the distribution of surplus assets upon the winding up of the company.

The default for shares without a designated class in a company are ordinary shares. Indeed, most companies only have one class of shares, known as ordinary shares. However, the company’s constitution, shareholders agreement, and terms of issue may modify the rights attached to ordinary shares, subject to the Corporations Act. It is important to review these constituent documents and any other conditions attached in relation to the ordinary shares to determine the precise scope of such shares.

Accordingly, ordinary shares form the foundation of your company’s share structure and typically carry voting rights to allow shareholders to participate in major decisions and elect directors. For the company, ordinary shares are a primary source of long-term capital. If declared, investors in ordinary shares are entitled to dividends and have a residual claim on the company’s assets in the event of liquidation. However, they bear a level of risk, as returns are not guaranteed. From a corporate governance perspective, ordinary shareholders have the right to vote on key decisions that impact them as shareholders.

Preference Shares

The next most common class of shares are ‘preference’ shares. Preference shares, as its name implies, confer upon preferential shareholders certain advantages or priority rights over shareholders with ordinary shares. For example, preference shareholders may have the following:

• dividend priority, meaning that if dividends are declared, preference shareholders would receive payment before ordinary shareholders; and
• capital recovery priority, meaning that in the event of insolvency preference shareholders have a higher claim than ordinary shareholders to recover their initial investment.

These preferential treatments, and others, distinguish preference shareholders from ordinary shareholders and offer enhanced benefits in specific areas of corporate participation.

Unlike debt, preference shares do not require regular interest payments or repayment of principal, which can improve the company’s balance sheet metrics. However, they still offer a fixed return to investors, similar to debt. This allows companies to raise funds without increasing their debt burden, potentially leading to a more favourable debt-to-equity ratio and improved financial flexibility. In terms of governance, the presence of preference shares may influence dividend policies and capital structure decisions.

Redeemable Preference Shares

Redeemable preference shares are unique in that the company can issue them but later pay back the issue price to redeem them. However, these shares must be approved by a special resolution of the shareholders or established in the company’s constitution. The key terms attached to redeemable preference shares generally include redemption circumstances, dividend rights, voting rights, and priority in asset distribution.

Accordingly, redeemable preference shares add an extra layer of flexibility. This provides the company with a way to raise capital with a built-in exit strategy. Investors may find these attractive due to the potential for higher returns and a defined investment horizon. Importantly, however, the redeemable nature of these shares requires careful cash flow management by the company, as funds must be available for redemption when due. This can have significant implications for corporate financial planning and governance.

Performance Shares

Performance shares automatically convert into ordinary shares when a company achieves a specified performance milestone. While performance shares can exist as a separate class of shares in some contexts, for small and medium sized enterprises and startups in Australia, it’s more common to implement performance-based equity incentives through Employee Share Option Plans (ESOPs) or Employee Share Schemes (ESS). In these arrangements, the underlying shares are typically ordinary shares, but their vesting or granting is subject to performance milestones.

Employees can exercise their options and receive ordinary shares if they achieve the targets. If they fail to meet the targets, the options may lapse, effectively serving the same purpose as performance shares without creating a separate share class. This approach allows companies to align employee interests with company performance and shareholder value while maintaining a more straightforward share structure. It provides the flexibility to incentivise employees, directors, or contractors based on performance without needing a distinct class of shares. 

Corporate Governance

While these performance-based equity incentives can drive positive outcomes, care must be taken in their design and implementation. Companies should ensure that the performance targets encourage sustainable long-term growth rather than short-term risk-taking. Therefore, these schemes’ structure, terms, and oversight become essential aspects of corporate governance, particularly in transparency and alignment with overall company strategy.

Investors should note that these schemes may dilute their holdings when the company meets performance targets, employees exercise options, or shares vest. However, dilution only happens after the company achieves specific performance milestones, which benefits all shareholders.

Key Takeaways

Your company in Australia can issue various share classes, each with distinct rights and characteristics. Each share class has unique implications for corporate governance, shareholder rights, and company financing strategies. The choice of share classes can significantly impact a company’s share structure, control dynamics, and ability to attract different types of investors. Ultimately, understanding these distinctions is crucial for effective corporate governance and promoting mutually beneficial investor relations.

If you have any further questions regarding share classes, our experienced corporate 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.

Frequently Asked Questions

How do preference shares differ from ordinary shares?

Preference shares give shareholders certain priority rights over ordinary shareholders, such as dividend priority (receiving dividends before ordinary shareholders) and capital recovery priority (higher claim on assets in case of insolvency). However, they usually come with limited or no voting rights.

What are performance shares, and how do they work?

Performance shares are shares that convert into ordinary shares only if specific performance milestones are met. These are commonly used in Employee Share Option Plans (ESOPs) or Employee Share Schemes (ESS) to incentivise employees and align their interests with company growth.