Summary
- Australian companies have significant flexibility in the share classes they issue, with the four most common types being ordinary shares (carrying voting rights, dividend entitlements, and residual asset claims), preference shares (providing dividend and capital recovery priority over ordinary shareholders), redeemable preference shares (allowing the company to repay the issue price and redeem the shares), and performance shares (converting to ordinary shares upon achievement of specified milestones).
- Preference and redeemable preference shares allow companies to raise capital without increasing debt, offering investors fixed returns and priority rights whilst preserving financial flexibility, though redeemable preference shares require careful cash flow management to ensure funds are available for redemption.
- Performance-based equity incentives are most commonly implemented through Employee Share Option Plans (ESOPs) or Employee Share Schemes (ESS) in Australian SMEs and startups, aligning employee interests with company performance whilst maintaining a straightforward share structure, though investors should be aware of potential dilution when performance milestones are met.
- This article is a guide to share classes for company directors and shareholders in Australia, explaining the common types of shares, their rights and characteristics, and their implications for corporate governance and financing.
- LegalVision is a commercial law firm that specialises in advising clients on corporate law and company structures.
Tips for Businesses
Review your company’s constitution, shareholders agreement, and terms of issue carefully before issuing any new share class to understand how rights may be modified from the default position under the Corporations Act. Consider the governance and cash flow implications of issuing preference or redeemable preference shares before proceeding. Seek legal and tax advice when designing employee equity incentive schemes to ensure performance targets promote sustainable long-term growth and comply with applicable legislation.
Each class of shares your company issues carries a distinct set of rights, characteristics and obligations, and the Corporations Act 2001 (Cth) (Corporations Act) gives proprietary limited companies and public companies significant flexibility in how they structure those classes. Getting this right is fundamental to how you organise corporate control, ensure investment flexibility and offer employee incentives. This article explains 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.
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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, LegalVision provides ongoing legal support for all businesses through our fixed-fee legal membership. Our experienced business lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
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.
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.
Ordinary shareholders can attend and vote at shareholder meetings, receive declared dividends, and participate in surplus asset distribution upon winding up. However, returns are not guaranteed, meaning ordinary shareholders bear a level of investment risk.
Yes, the company’s constitution, shareholders agreement, and terms of issue can modify ordinary share rights, subject to the Corporations Act. Always review these constituent documents to determine the precise scope of rights attached.
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