Understanding the Different Types of Shareholders in a Company
Introduction
Shareholders play a crucial role in the structure and governance of companies, as they own a portion of the company through their investment in shares. In Australia, the two primary types of shareholders are common shareholders and preferred shareholders. Both shareholder types possess distinct characteristics, rights, and benefits. This article aims to provide an in-depth analysis of the differences between common and preferred shareholders in Australian companies.
Common Shareholder
Common shareholders are the most prevalent type of shareholders in Australian companies. They own what are known as ordinary shares, which represent an equity interest in the company. Common shareholders have several rights and privileges, which are outlined below.
a) Voting Rights
One of the most significant distinctions between common and preferred shareholders is the right to vote on various company matters. Common shareholders typically have the right to vote on issues such as electing directors, approving mergers and acquisitions, and amending the company’s constitution. Each share owned by a common shareholder usually carries one vote, although some companies may issue non-voting common shares.
b) Dividends
Common shareholders may receive dividends, which are a portion of the company’s profits distributed to shareholders. However, dividend payments are not guaranteed and depend on the company’s financial performance and the board of directors’ decisions. If the company decides to pay dividends, common shareholders will receive their share based on the number of shares they own.
c) Capital Appreciation
Common shareholders can benefit from capital appreciation, which occurs when the company’s share price increases over time. This allows shareholders to potentially make a profit when they sell their shares, although the value of shares can also decrease.
d) Liquidation Rights
In the event of a company’s liquidation, common shareholders have the right to receive any remaining assets after all secured creditors, debts, liabilities, and preferred shareholders’ claims have been settled. However, common shareholders are last in line, which means they may not receive anything if the company’s assets are insufficient to cover all outstanding obligations.
Preferred Shareholder
Preferred shareholders own preferred shares, which are a hybrid form of investment that combines elements of both equity and debt. These shares carry several unique features, making them distinct from common shares.
a) Dividend Preference
One of the primary benefits of owning preferred shares is the preferential treatment regarding dividend payments. Preferred shareholders typically receive a fixed dividend rate, which is paid out before any dividends are distributed to common shareholders. This feature ensures that preferred shareholders have a higher degree of income stability compared to common shareholders.
b) Priority in Liquidation
In the event of a company’s liquidation, preferred shareholders have a higher priority than common shareholders when it comes to the distribution of assets. This means that preferred shareholders will be paid before common shareholders, reducing their risk of loss in case the company goes bankrupt.
c) Limited Voting Rights
Preferred shareholders generally have limited voting rights compared to common shareholders. They usually do not have the right to vote on most company matters, such as electing directors or approving mergers and acquisitions. However, preferred shareholders may gain voting rights under specific circumstances, such as when their dividends are in arrears or if the company wants to amend the terms of the preferred shares.
d) Convertibility
Some preferred shares may have a convertible feature, allowing preferred shareholders to convert their shares into a predetermined number of common shares. This conversion can be advantageous for preferred shareholders if the company’s common shares appreciate significantly in value.
Partly-Paid Shareholders
Also known as contributing partly-paid shares are issued without full payment for the share full issue price, a method used by companies to incentivise investors to participate in their company. At a specified date in the future, the company is entitled to call for all or part of the outstanding issue price, and the shareholder is legally obliged to pay the call.
Generally, a shareholder of partly-paid shares has the same rights as an ordinary shareholder to vote, to dividends and on winding up of the company, but those rights will be proportional to the amount paid on the share. For example, if you only pay 75% of the issue price for a share, you will only be entitled to 75% of dividends and voting rights, except for a vote by show of hands, where a holder of a partly paid share has one vote, being the same as any ordinary shareholder.
Comparing Common and Preferred Shareholders
The main differences between common and preferred shareholders in Australian companies can be summarized as follows:
- Voting Rights: Common shareholders typically have the right to vote on various company matters, while preferred shareholders generally have limited or no voting rights.
- Dividends: Common shareholders may receive dividends, but these payments are not guaranteed and depend on the company’s financial performance and board decisions. In contrast, preferred shareholders receive fixed dividend rates and enjoy dividend payment preference over common shareholders.
- Capital Appreciation: Common shareholders can benefit from capital appreciation if the company’s share price increases. Preferred shareholders, on the other hand, may not experience the same level of capital appreciation due to the fixed nature of their dividend payments. However, they can potentially benefit from capital appreciation through convertible preferred shares.
- Liquidation Rights: In the event of a company’s liquidation, preferred shareholders have a higher priority than common shareholders when it comes to the distribution of assets. Common shareholders are last in line and may not receive anything if the company’s assets are insufficient to cover all outstanding obligations.
- Risk and Reward: The risk-reward profile of common and preferred shareholders differs significantly. Common shareholders generally face higher risks due to their lower priority in liquidation and uncertain dividend payments. However, they may also enjoy higher rewards in the form of capital appreciation and potential dividend growth. Preferred shareholders, in contrast, have a more stable income stream through fixed dividends and higher priority in liquidation, but they may miss out on the potential for significant capital appreciation.
Understanding the differences between holding common and preferred shares is essential for investors and business owners alike. Common shareholders typically have voting rights and can benefit from capital appreciation but face higher risks due to their lower priority in liquidation and uncertain dividend payments. On the other hand, preferred shareholders enjoy preferential treatment in dividend payments and liquidation priority, providing them with more income stability and reduced risk, but may miss out on the potential for significant capital appreciation.
In summary, the choice between common and preferred shares depends on an investor’s risk tolerance, investment objectives, and desired income stability. By carefully evaluating the characteristics of each shareholder type, investors can make informed decisions that align with their financial goals and preferences.
Your employees come first. And if you treat your employees right, guess what? Your customers come back, and that makes your shareholders happy. Start with employees and the rest follows from that.
Herbert David Kelleher – CEO & Emeritus Chariiman, Southwest Airlines
Additional Considerations for Investors
When deciding between investing in common shares or preferred shares, several additional factors should be considered, including:
- Market Conditions: Market conditions can influence the attractiveness of common and preferred shares. During periods of economic growth, common shares may be more appealing due to the potential for capital appreciation and dividend growth. Conversely, during periods of economic uncertainty or downturns, preferred shares may offer more stability and income predictability.
- Company Performance: The performance of the company issuing the shares is also an essential factor to consider. A company with a strong financial position and growth prospects may provide better returns for common shareholders through capital appreciation and dividend growth. In contrast, a company with a more uncertain future may make preferred shares a safer choice for investors seeking income stability.
- Diversification: Diversification is a critical component of any investment strategy, and investors could consider holding a mix of common and preferred shares in their portfolios. This approach can help to balance the potential for capital appreciation with the stability of fixed dividend payments, reducing overall portfolio risk.
- Tax Implications: The tax treatment of dividends may also impact the attractiveness of common and preferred shares for investors. In Australia, dividends from common shares can be subject to franking credits, which can offset the tax payable on dividend income. Preferred share dividends may not always be eligible for franking credits, depending on the specific terms of the shares. Investors should consult with a tax professional to understand the tax implications of their investment choices.
- Investment Horizon: An investor’s investment horizon, or the length of time they plan to hold the investment, can also influence the choice between common and preferred shares. Long-term investors may be more inclined to invest in common shares, given the potential for capital appreciation and dividend growth over time. Short-term investors or those seeking regular income may find preferred shares more suitable due to their fixed dividend payments and lower price volatility.
The decision to invest in common or preferred shares in Australian companies depends on various factors, including an investor’s risk tolerance, investment objectives, market conditions, company performance, and investment horizon. By considering these factors and understanding the differences between common and preferred shareholders, investors can make more informed decisions that align with their financial goals and preferences. A diversified approach, incorporating both types of shares in an investment portfolio, can also help to balance risk and reward, providing a more stable and potentially profitable investment experience.
Shareholders’ Agreement – Periodic Reviews and Updates
Over time, the circumstances of the company or its shareholders may change, necessitating updates to the shareholders’ agreement. It is essential to periodically review the agreement to ensure it remains relevant and reflects the current needs and objectives of the company and its shareholders. Any necessary amendments should be made with the assistance of a legal professional to ensure ongoing compliance with the Corporations Act 2001 and other applicable laws.
Shareholders’ agreements are a vital aspect of corporate governance in Australian companies, providing clarity on shareholders’ rights and obligations, protecting minority shareholders, facilitating decision-making and dispute resolution, controlling share transfers, and assisting with business succession planning.
To ensure that a shareholders’ agreement effectively serves its purpose, it is crucial to seek legal advice and assistance in drafting and reviewing the document, customising it to suit the specific needs of the company and its shareholders, and ensuring compliance with the Corporations Act 2001 and other relevant legislations.
By Gregory Atamian JJN Associates – Accountants Tax Advisor
The content and the references made in this article are correct as at the publication date and are for general information and should not be relied upon as advice. If you wish to seek particular advice, call us on 02 9997 4000.