What are Ordinary Shares?
Ordinary shares, often referred to as common stock, are units of equity ownership issued by a company primarily to its founders. These shares grant holders certain privileges over preference shares, particularly in corporate governance, such as voting rights on important company decisions.
However, in the financial hierarchy, ordinary shares are subordinate to preference shares. This means that in situations of company liquidation or when dividends are distributed, the claims of ordinary shareholders are addressed after those of preference shareholders are satisfied.
Ordinary shares can be issued either fully paid, where the shareholder has paid the full value of the shares at the time of purchase, or partly paid, where some portion of the share value remains unpaid, to be settled at a later date or upon specific conditions being met.
Regulatory Framework for Ordinary Shares
In Australia, the legal framework governing ordinary shares is primarily established under the Corporations Act 2001, which sets forth the regulations for company operations and securities management. This Act details the rights and obligations associated with ordinary shares, including issuance procedures, shareholder rights, and the specifics of dividend distributions.
Additional legal guidance is provided by the Australian Securities Exchange (ASX), which imposes its own set of listing rules that companies must comply with to maintain the trading of their shares on the exchange. These regulations ensure transparency, fairness, and efficiency in the trading and management of ordinary shares, helping to protect investors and maintain the integrity of the financial market.
Rights Attached to Ordinary Shares
Voting Rights and Their Influence on Corporate Decisions
In Australia, holders of ordinary shares typically have the right to vote at shareholder meetings. This fundamental right enables them to influence corporate governance and decision making processes, including the election of board members and the approval of major corporate actions such as mergers, acquisitions, and changes to the corporate charter. Voting typically occurs on a per share basis, granting shareholders a proportionate influence in line with their investment.
The Corporations Act 2001 ensures that these voting processes are conducted fairly and transparently, reinforcing the role of shareholders in steering the company’s strategic directions.
Dividend Rights and Profit Sharing
Ordinary shareholders in Australian companies are entitled to receive dividends declared by the company. These dividends are typically paid from the profits of the company and can be variable, depending on the company’s profitability and board decisions.
The Corporations Act 2001 stipulates that dividends can only be paid out of profits or otherwise legally available funds, and the company must satisfy a solvency test before making any dividend payments. This legal framework ensures that dividends are distributed responsibly without compromising the financial stability of the company.
Rights to New Shares and Other Entitlements
During periods of company expansion or restructuring, ordinary shareholders may have rights to new shares issued by the company, often referred to as pre emptive rights or rights issues. These rights allow existing shareholders to maintain their proportional ownership in the company by purchasing additional shares before they are offered to the public.
The Corporations Act 2001 provides regulations for how these rights must be managed, ensuring that all shareholders are given a fair opportunity to participate in new share offerings.
Additional Rights of Ordinary Shareholders
Beyond the primary rights of voting, dividends, and rights to new shares, ordinary shareholders in Australia also enjoy several other legal protections and entitlements:
- Right to access company information
- Right to attend and speak at meetings
- Right to participate in major decisions
- Right to appoint and remove Directors
These rights collectively empower ordinary shareholders to actively participate in the governance of their investments, ensuring that their interests are adequately represented and protected under Australian law.
Limited Liability of Shareholders
Limited liability is a fundamental principle that protects shareholders in a corporation. Under this principle, the financial liability of the shareholders is restricted to the amount they have invested in purchasing the shares of the company. This means that if the company incurs debt or faces legal claims, the personal assets of the shareholders are shielded from being used to satisfy company debts or liabilities.
In Australia, this protection is codified under the Corporations Act 2001, which establishes that shareholders are not personally responsible for the company’s obligations. Therefore, in the event of bankruptcy or liquidation, shareholders will lose only their investment in the shares and not be subjected to any further financial demands related to the company’s liabilities.
Issuance and Trading of Ordinary Shares
The issuance of ordinary shares in Australia can occur through public offerings or private placements. A public offering, often facilitated through an initial public offering (IPO), allows a company to raise capital from the general public by listing shares on a stock exchange such as the ASX.
This process requires rigorous disclosure and registration with ASIC, including the preparation of a prospectus that details the company’s financials, risks, and the terms of the share offering. Private placements involve selling shares to a select group of investors, typically institutional investors, without a public offering, which can be faster and less costly in terms of regulatory requirements.
Transferability of Shares
Ordinary shares are generally freely transferable, allowing shareholders to sell their shares on the open market unless restricted by the company’s constitution or a shareholder agreement. The ASX oversees the trading of shares and imposes rules to ensure an efficient, competitive, and informed market. For example, the ASX Listing Rules require companies to disclose information that could affect the price or value of their shares, thereby ensuring that all market participants have access to the same information. The ASX also monitors trading activities to prevent market manipulation and to protect the integrity of the market.
These responsibilities and processes underscore the critical role of ordinary shareholders and the regulatory framework that supports transparent and fair trading of shares in Australia’s financial markets.
Ordinary Shares – Advantages
Influence on Company Direction through Voting Rights
Ordinary shareholders have the significant advantage of influencing the strategic direction of a company through their voting rights. By participating in shareholder meetings and casting votes on crucial issues, they play a direct role in shaping corporate policies, electing board members, and making decisions on significant corporate actions. This active involvement allows them to help steer the company towards growth and operational success.
Access to Company Information and Financial Reports
Holding ordinary shares provides individuals with the right to access key company documents, including annual financial reports and other disclosures. This transparency allows shareholders to monitor the company’s performance, assess its financial health, and make informed decisions regarding their investment. Such access is especially valuable for those who are keenly interested in the company’s operations and wish to stay informed about its progress and prospects.
Potential for Higher Returns on Investment
Ordinary shareholders stand to benefit from potentially higher dividends when the company performs well financially. Unlike preferred shareholders, who receive a fixed dividend, the dividends for ordinary shares are typically variable and can increase with the company‘s profitability. This aspect of ordinary shares holds the promise of unlimited upside potential, allowing shareholders to benefit proportionally from the company‘s success.
Advantages in Corporate Acquisitions
In the event of a corporate buyout or acquisition, ordinary shareholders may receive a more favourable outcome compared to preferred shareholders. Since their dividends are not capped, any premium paid during the acquisition could result in a larger payout to ordinary shareholders, reflecting their proportional stake in the company‘s increased valuation.
Ordinary Shares – Disadvantages
Higher Financial Risk Without Guaranteed Dividends
Ordinary shareholders face a higher level of financial risk compared to preferred shareholders because they are not entitled to guaranteed dividend payments. Preferred shares typically come with a fixed dividend, offering more stability and predictability in returns.
In contrast, dividends for ordinary shares depend on the company’s profitability and the discretion of its board, which may decide to reinvest profits back into the business instead of distributing them as dividends.
Subordination in Dividend Payments
While ordinary shareholders are entitled to dividends, they receive these only after all obligations to preferred shareholders have been met. This arrangement does not guarantee that ordinary shareholders will receive dividend payments, as the company may choose to retain earnings to support operational needs or future growth initiatives, potentially at the expense of dividend payouts to ordinary shareholders.
Lack of Redemption Rights
Preferred shares often include a call feature, allowing the issuing company to buy back these shares at a predetermined price, providing preferred shareholders with an additional exit strategy under certain conditions.
Ordinary shares lack this feature, leaving their holders more susceptible to market fluctuations. The value of ordinary shares is entirely subject to the market’s performance, which can lead to significant volatility in their investment value without the cushion of redemption rights.
Preference Shares
What are Preference Shares?
Preference shares are a class of company ownership that offer specific financial advantages over ordinary shares. The primary benefit is the prioritisation of dividend payments, where dividends are disbursed to preference shareholders before any dividends are paid to ordinary shareholders. This prioritisation also extends to the company’s assets in the event of bankruptcy, with preference shareholders receiving payouts before ordinary shareholders.
The structure and risk associated with preference shares can vary, making it essential for investors to thoroughly understand the specific terms and conditions of the preference shares they consider investing in. Each variant of preference shares might offer different levels of risk and returns, influenced by their specific dividend rates, redemption policies, and other terms that could affect their overall investment value.
Preference shares blend elements of both debt and equity, leading to their classification as either hybrid or convertible securities. These shares can exhibit properties akin to bonds, such as having a fixed maturity date, and can be issued by both private and public companies. Publicly listed preference shares are traded on the Australian Stock Exchange (ASX).
Convertible Preference Shares
Convertible Preference shares are initially issued with fixed dividend payments, which are paid out at regular intervals. At a predetermined time and rate, convertible preference shares can be transformed either into ordinary shares or redeemed for cash, providing flexibility in investment strategy and potential for capital growth.
Converting Preference Shares
Distinct from convertible preference shares, converting preference shares are designed to eventually convert into ordinary shares. This conversion is typically executed at a specified dollar amount, aligning the investment’s outcome closely with the performance of the company’s ordinary shares.
Cumulative Preference Shares
For cumulative preference shares, if a company is unable to pay dividends when due, these dividends accumulate rather than lapse. The accrued dividends are then paid out once the company regains financial stability. Ordinary shareholders only receive dividends after all owed dividends to cumulative preference shareholders have been fully paid, providing a layer of security for investors regarding dividend payments.
Redeemable Preference Shares
Redeemable Preference shares come with the option for the company to buy them back, which allows shareholders to redeem their shares for cash. The terms of redemption, including the timing and the price, are typically at the company’s discretion, offering companies flexibility in managing their equity structure.
Why invest in Preference Shares?
Preference shares attract a specific type of investor, generally those seeking a more secure form of investment compared to typical equity instruments like stocks or bonds. These shares are appealing because they offer fixed income returns, which provide stability and predictability in investment outcomes. This characteristic makes preference shares particularly suitable for investors who prioritise income certainty over the potential for high capital gains.
However, the security and fixed income features of preference shares can also limit their appeal to a broader investor base. Unlike ordinary shares, which can attract a wide range of investors due to the potential for high returns through capital appreciation, preference shares do not offer the same level of upside.
As a result, the pool of investors interested in preference shares is often narrower, which can pose challenges for companies attempting to raise significant capital through the issuance of preference shares. This situation often makes it more challenging for companies to rely solely on preference shares for large fundraising needs.
Preference Shares Rights
Voting Rights
Often, preference shares do not come with voting rights. This absence of voting privileges differentiates them from ordinary shares, which typically allow shareholders to vote on corporate decisions.
Dividend Rights
Preference shares are often structured to provide priority dividends. The governing documents of a company, such as its bylaws or shareholder agreements, detail these rights. Typically, dividends to preference shareholders are either a fixed percentage of their investment or are prioritised over dividends to ordinary shareholders. This provides preference shareholders with a higher certainty of receiving a return on their investment before any dividends are distributed to ordinary shareholders.
Liquidation Preferences
In the event of company insolvency, preference shareholders have superior rights over ordinary shareholders concerning asset distribution. They are typically entitled to recover either the original amount invested or an amount based on how assets would be divided among all shareholders, whichever is greater.
This right is termed as a liquidation preference. Additionally, any preferential dividends that preference shareholders receive are usually subtracted from the total amount they obtain during the liquidation process.
Participating Liquidation Preferences
Some preference shares come with a fully participating liquidation preference, which is particularly favourable for investors. This arrangement not only allows preference shareholders to recover their initial investment in the event of liquidation but also enables them to share in any remaining company profits alongside ordinary shareholders. This dual benefit allows them to double dip, maximising their potential returns from the investment.
Preference Shares Disadvantages
Lack of Voting Rights
One of the significant disadvantages of holding preference shares is the lack of voting rights. This can be a critical drawback for investors who wish to have a say in the company’s management and decisions. Unlike ordinary shareholders who typically have voting rights at shareholders’ meetings, preference shareholders usually do not influence managerial decisions, which can affect their control over their investment.
Fixed Dividend Rates
Although the fixed dividends associated with preference shares provide a predictable income, this can also be a limitation. Fixed dividends mean that preference shareholders do not benefit from increases in the company’s profitability beyond the agreed rate. In times of significant profit growth, ordinary shareholders might receive substantially higher dividends, whereas preference shareholders are capped at their fixed rate.
Limited Upside Potential
Related to the fixed dividend rate is the limited upside potential of preference shares. Because they typically do not appreciate in value in the same way that ordinary shares can, preference shareholders might not benefit from increases in the share price due to market growth or company performance. This limitation can make preference shares less attractive during bull markets when investors could gain more from capital appreciation.
Complexity in Conversion and Redemption
Preference shares often come with options for conversion to ordinary shares or redemption at certain times under specific conditions. These features can introduce complexity and uncertainty regarding the timing and value of conversions and redemptions. Investors need to understand these terms fully, as poor timing or unfavourable market conditions at the time of conversion or redemption can lead to suboptimal financial outcomes.
Market Liquidity
Preference shares might have lower liquidity compared to ordinary shares, especially if they are not widely traded. This lower liquidity can make it more difficult for investors to sell their shares quickly without impacting the price, potentially leading to less favourable selling conditions.
Dividend Access Shares
What are Dividend Access Shares?
Dividend Access Shares are a corporate financial management tool, enabling selective dividend distribution without corresponding voting rights. They are issued under specific conditions which are typically defined in the company’s shareholder agreement or its constitution. Dividend Access Shares are sometimes referred to as Discretionary Shares, as they enable discretionary payments of dividends to shareholders of these shares.
These shares are not meant to confer an ownership interest in the usual sense but rather to serve as a vehicle for passing profits to certain individuals or entities.
Dividend Access Shares are particularly relevant for closely held companies or family owned businesses where there is a need to distribute profits among members without altering the existing power dynamics or ownership structure. Their usage supports tax planning strategies and can be critical during periods of restructuring, estate planning, or corporate succession.
Right to Dividends
One of the most prominent features of Dividend Access Shares is their entitlement to dividends. This right is uniquely discretionary; dividends can be declared by the company’s directors specifically for this class of shares depending on the company’s financial performance and dividend policies.
No Voting or Residual Rights
Unlike ordinary shares, Dividend Access Shares do not carry voting rights. Shareholders with Dividend Access Shares do not participate in the decision making processes of the company. This feature is particularly advantageous in maintaining control within a select group while still distributing profits to a wider circle.
Furthermore, these shares do not grant any rights to the company’s residual assets upon liquidation, which means they purely serve a financial distribution role without impacting corporate governance or asset distribution after the company ceases operations.
Typically Issued for Nominal Consideration
Dividend Access Shares are often issued for a nominal consideration, which means they can be acquired at minimal cost. This makes them an attractive option for including new stakeholders in dividend plans without significant capital outlay or altering the existing balance of financial investment in the company.
Dividend Access Shares – Practical Applications
Asset Protection
Dividend Access Shares are often used as a strategic tool for asset protection. By separating the dividend rights from other shareholder rights such as voting and claims on assets, Dividend Access Shares can be used to distribute profits to shareholders without exposing these assets to potential creditors. This is particularly useful in businesses where owners wish to protect accumulated profits while maintaining control over the company.
Estate and Succession Planning
In estate and succession planning, Dividend Access Shares can facilitate the smooth transition of wealth without disrupting the operational control of the business. They allow for dividends to be passed to heirs or successors without necessarily giving them control over the business decisions, thus preserving the founding or current generation’s management while supporting the next generation financially.
Employee Share Schemes
Dividend Access Shares can be incorporated into employee share schemes to align employee interests with those of the company by allowing employees to benefit from dividends. This can be an incentive that rewards employees for the company’s success without conferring voting rights, which typically remain with the senior management or the company founders.
Corporate Restructuring
During significant events such as divorces, mergers, or acquisitions, Dividend Access Shares can be used to restructure ownership and profit sharing arrangements without altering control dynamics. For example, in a divorce, one party may retain control over the business while the other receives Dividend Access Shares as a form of settlement, providing income without granting control or ownership.
Dividend Access Shares – Risks
The misuse of Dividend Access Shares can lead to significant legal and financial repercussions. For instance, if Dividend Access Shares are used primarily as a tax avoidance scheme, it could attract scrutiny and penalties under anti avoidance provisions. Mismanagement or opaque structuring of Dividend Access Shares could also result in disputes among shareholders, especially if the distribution of dividends is seen as unfairly favouring certain parties over others.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.