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Preference Shares vs Ordinary Shares

Preference Shares vs Ordinary Shares

Shares come with specific ownership rights and these rights can differ between the types of shares available. Have you ever wondered what the difference is  between preference shares and ordinary shares? 

For preference shares, the shareholders enjoy ownership rights of the company that grant them certain privileges over others. They are sometimes also called “preferred shares”. Conversely, ordinary shares only grant ownership rights to their holders but without any preferential treatment over others. Another name for ordinary shares is “common shares”. 

Keep reading as we learn the differences between preference and ordinary shares. We will discuss eligible buyers and the types of companies that can offer them.

 

What Are Preference Shares?

Preference shares are shares in a company known as stock and the purchase of these shares grants shareholders dividends that take higher payment priority over others. Preference shareholders must be first paid over ordinary members whenever the company has to share profits or capital during liquidation, 

Many companies favour preference shares because it is a more secure capital that can function as an attractive alternative to debt financing. Ordinary shareholders are likely to lose more if the company ever dissolves while preference share owners enjoy preferential access to dividends and repayment of capital. 

Who Can Distribute Preference Shares?

Only publicly listed companies can issue preference shares since they are the only company types subjected to the disclosure requirements of stock exchanges and relevant regulatory bodies. 

Public listed companies refer to organisations that are traded on a public stock exchange. Their ownership comprises all the shareholders that own shares in that company. 

Since they are publicly listed, these companies must comply with the listing requirements of the relevant exchange. A publicly listed company should also provide detailed information about its operations, finances and directors. It is necessary to disclose this information to the public to help potential investors make informed decisions before committing their money 

 

Who is Drawn to Investing in Preference Shares?

Preference shares are the perfect company stock for investors who are quite conservative, risk-averse and only seek a safe and reliable income source. This share class also appeals to investors seeking long-term capital growth and significant voting rights. They do not worry about getting ordinary shares since their preference shares can always be converted to ordinary shares if the situation demands it.

The main perks that attract most investors to preference shares are the high dividend payments, lower volatility, steady cash flow generation and limited risk potential. 

What Are Ordinary Shares?

Ordinary shares are company stock that grants shareholders the right to potentially benefit from capital appreciation and dividend payment. It is sometimes called common stock. 

There are a few downsides to owning an ordinary share. Firstly, common shareholders are not a priority when profit is shared. Ordinary share owners are paid their dividends according to the regulations of the Company’s Articles of Association. 

Another challenge is how the preference shareholders have higher voting rights although ordinary share owners are permitted to participate in the management decision-making. That includes processes like electing directors or accepting significant transactions. 

Who Can Distribute Ordinary Shares?

Both publicly listed companies and private companies are authorised to distribute or release ordinary shares. Ordinary shares do not need a disclosure requirement like preference shares. There are also no specific listing criteria to meet. 

 

Who is Drawn to Investing in Ordinary Shares?

Ordinary shares appeal to investors who are less risk-averse and want to get their investment rewards through capital growth. They do not have as much security on dividend payments as the preference shares. However, ordinary shares are a favourable option for those looking to generate an income. They also present more potential returns but with corresponding greater risk.

An investor will have to weigh the benefits and drawbacks when choosing between preference and ordinary shares. As a preference shareholder, they will likely benefit from priority payments and enjoy more security. The downside is the possibility of limited access to voting rights or capital appreciation.  

Ordinary shareholders potentially enjoy more returns but with greater risks. The best decision depends on the personal interest of the investor. 

An Overview Of Preference & Ordinary Shares

Preference and ordinary shares are corporate securities that signify stakes in company ownership. They grant ownership rights to shareholders but differ in how dividends and voting rights are shared. Preference shareholders also have different privileges compared to ordinary shareholders. 

As an investor, it is essential to understand the specific rights and privileges associated with each share class. You should also inquire about the tax implications as a shareholder before investing. The class of share you prefer depends on your financial goals. 

Dividends:

The dividend payment is one major difference between preference and ordinary shares. Preference shareholders usually get higher dividends than ordinary shareholders. The reason is simple – preference shareholders of the company get paid before returns are allocated to other stakeholders. They enjoy an advantage over members who own regular stocks. 

Voting Rights:

Voting rights among shareholders is another benefit of owning a preference share over ordinary shares. Preference shareholders enjoy greater influence on the company’s decision-making process. Ordinary members do not have much influence when it comes to voting to make decisions. 

Conversion Rights:

Preference shareholders have another advantage with their conversion rights. This implies they can convert their shares into ordinary or common shares to expand their ownership stake in the company. Unfortunately, ordinary shareholders do not have that privilege and that poses a risk of getting only ordinary shares in a company. It limits your investment options in the long run. 

Liquidity:

Ordinary shareholders have the edge here since their shares are often liquid and much available on the market. That results in easier exchange on the stock exchange market when trading becomes difficult. Compared to their ordinary shares owners, preference shareholders are very limited in terms of stock liquidity. 

Risk:

Generally, preference shares are less risky to own than ordinary shares primarily because of the difference in dividend payments. Preference shareholders have higher dividends that increase their chance to get investment returns even when the company performs poorly on the market. Preference shareholders are liable to lower risks since they can convert their shares to ordinary ones if they need to expand their stake. 

 

Advantages Of Preference Shares

There are various advantages of preference shares over ordinary shares such as preferential dividend payments. Preference shareholders enjoy an earlier allocation of the liquidation process before the distribution to other shareholders. The additional benefits include limited voting rights that allow investors greater control in corporate decisions. Every preference shareholder enjoys more guaranteed profits since their dividends are paid before others. 

Disadvantages Of Preference Shares

There are a few downsides of preference shares for both the company and investors. Firstly, the company pays extra money to extend preferential rights over other shareholders in exchange for issuing preference shares. Additionally, the shares have fixed dividends which minimises its capacity to appreciate capital gain compared to ordinary share dividends that increase with company performance. 

Advantages Of Ordinary Shares

The major advantages of ordinary shares are their capital appreciation potential, voting rights, and cost-effectiveness. Ordinary shareholders enjoy a direct say in the company’s decisions concerning investment opportunities. 

These benefits are some of the reasons that appeal to potential investors despite the extra costs associated with buying regular stock. Many companies also prefer ordinary shares to preference shares because they are substantially cheaper and easy to issue in the long run.

Disadvantages Of Ordinary Shares

The lack of preferential rights like the preference shareholders is a major disadvantage of ordinary shares. There is also the problem of a slight delay in payments of dividends and proceeds from liquidation until preference shareholders get paid. 

These procedures stated in the company’s articles of association are not beneficial for the common or ordinary shareholders. The implication is a higher financial security risk for ordinary shareholders especially when the company poorly performs on the market. 

How To Become A Shareholder In A Business

You have to buy shares of a company to become a shareholder of that business. Shares are available on the open market such as the New York Stock Exchange or through private transactions.

A company could also decide to directly issue shares to investors through initiatives such as conducting a share offering and initial public offering (IPO). 

The choice of what type of share to buy depends on an individual’s risk tolerance and investment goals. Business investors who prioritise the security of profits might choose preference shares for the generous dividend payment plan. Another investor might decide to try ordinary shares for their higher returns and greater risks because of the zero preferential treatment. The delay in dividend payment or liquidations for ordinary shares poses a potential loss of money.

You become a shareholder once you purchase the shares and get payment confirmation. The company must also send proof of your eligibility to receive dividend payments and other stock benefits associated with the type of stock you bought. 

Do All Businesses Have Preference Shares & Ordinary Shares?

Not all businesses have preference shares and ordinary shares as each company decides what share class to use as securities. Some companies sell both share classes while others have only one.

The main consideration factors for companies regarding the type of shares to have depend on their perception of the different rights and privileges that preference and ordinary shareholders enjoy. 

 

How To Buy Shares?

Most companies offer their shares online through a broker or stock exchange to prospective investors. The purchase process is not complex since investors get access to their portfolios immediately after their purchase is confirmed. 

As investors, they have a platform to monitor the performance of their investments in the company’s stock. Whether you are a preference or ordinary shareholder, buying shares is some risk and you must conduct your research before committing your money. 

What Are The Tax Implications Of Investing In Preference Shares & Ordinary Shares?

The tax implication on purchasing stocks of a company varies depending on factors like the type of share, amount invested, industry of the company, and location of the shares. 

Preference shareholders are usually liable to capital gains taxes while ordinary shareholders might become liable to income taxes on paid dividends. We recommend contacting a qualified account or tax advisor to help decide which type of share classes is best suitable for you. 

 

How Does Investing In Preference Shares & Ordinary Shares Differ?

There are certain differences between owning a preference or ordinary shares. For example, preference shareholders enjoy some priority in payment terms of dividends and capital on liquidation. They might also be entitled to a few additional rights or privileges over ordinary shareholders. 

Other differences include the tax implications for each share class. The liable taxes for preference and ordinary shares are not the same. You might want to talk to a professional advisor on how to understand the different tax implications. 

What Are Voting Rights For Shareholders?

Shareholders typically have a say in some important corporate decisions like electing board members or approving mergers and acquisitions. Their voting rights depend on the number of company stock or shares they have. One share equals one vote. However, a preference shareholder might not have voting rights while ordinary shareholders almost usually have. 

What Are Conversion Rights For Shareholders?

Conversion rights refer to the privileges that allow an investor to convert their shares from one class to another. For example, converting a preference share to ordinary shares. That is the only possible route as you cannot convert ordinary stocks to preference ones. 

The idea of conversion rights is for investors who want to expand their control over a company or enjoy exclusive perks associated with a different share class. Note that the exact conversion process of the shares depends on the type of company stock you’re converting. 

Summary

Preference and ordinary shares are two different types of securities a company issues to interested investors in its stock. Ordinary shareholders usually do not enjoy preferential rights to dividend or liquidation payments. It is quite different for preference shareholders since they enjoy preferential rights and higher priority over other shareholders in terms of dividend payments. 

There are also different risk levels and tax implications associated with both share classes. For example, capital gains tax is usually levied on preference shares while ordinary shareholders are liable to income taxes. Getting a professional tax advisor can help you understand the different tax requirements. 

Lastly, both classes of shareholders have varying voting rights depending on the company’s terms and conditions. It is sometimes possible for a preference shareholder to not have voting rights. 

 

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