Now that you’ve started your startup, you might be turning your attention to securing funding and growing your business. One of the ways in which you can do this is through equity financing. In short, equity financing is where a company issues shares in its company and the company receives money in return for those shares. Below, we explain the differences between ordinary shares and preference shares.
An ordinary share represents ownership in a company and gives the shareowner the right to vote on matters put before all of the shareholders of the company. The weight of a particular shareholder’s vote will depend on the ownership percentage that shareholder has 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 all the liabilities (including those to preference shareholders) of the company have been paid. The amount of dividends an ordinary shareholder receives fluctuates and depends on how well the company is performing. Ordinary shareholders are usually founders of the company, family and friends.
As the name suggests, preference shares give the preference shareholder some form of preferred treatment to the ordinary shareholder. That treatment is, most commonly, in the form of regular dividends and a priority right to be repaid should the company become insolvent.
Dividends paid to a preference shareholder are usually fixed which is not the case for those in respect of ordinary shares. Fixed dividends allow the preference shareholder to have more certainty over their investment than ordinary shareholders.
If the company is underperforming, the payment of fixed dividends will be an interesting return for the investor. On the other hand, if the company is doing well, then it could be the ordinary shareholder who may have a higher dividend payment. It is important to keep in mind that paying dividends is at the discretion of the company. Shareholders will only receive dividends once the liabilities of the company have been paid. As far as priority is concerned, the preference shareholders receive their fixed dividend before the ordinary shareholders.
If a company enters insolvency (that is, it can no longer pay its debts as and when they fall due), then preference shareholders will have priority over the ordinary shareholders to recover their investment.
Which One is Better?
Both types of shares have advantages and disadvantages. An ordinary share has voting rights which allows the ordinary shareholder to have a say in the direction and control of the company. Generally speaking, a preference share does not have voting rights. If the company is doing well, the ordinary shareholder may receive higher dividends than a preference shareholder. Comparatively, a preference shareholder’s right to dividends will be fixed so when the company may not be as profitable, a preference shareholder may receive more dividends than an ordinary shareholder.
There are many matters to consider when looking for funding for your company. If you have any questions about capital raising or issuing shares to potential investors, get in touch on 1300 544 755.