When trying to secure finance for your business, a potential route is to seek investment. There are many benefits in doing this, such as gaining funds for your business without placing the strain of repayment on your cash flow.
For investment to work, you need to offer individuals or corporate entities equity in your business in the form of shareholding, in exchange for their funding in the form of shares. Over time, it is hoped that these shares will appreciate in value, giving investors profit on their initial investment.
However, issuing new shares can be problematic for some companies, as it means diluting your existing shareholdings, making business decisions all the more complex and sharing any profit distribution (dividends) with these additional shareholders.
Fortunately, there are a number of different types of shares that a company is able to offer, designed and structured differently to suit different circumstances and create an amicable arrangement that works for all parties. Our guide explores the different types of shares available and why a company may choose to use them.
What are ordinary shares?
In most cases, a company will stick to just one type of share, in which all investors have the same rights and entitlements. These are known as ordinary shares.
With ordinary shares, investors will be entitled to the same voting rights over business decisions and will receive the same level of profit share via dividends, both in proportion to the number of shares they hold of the whole. The benefit of ordinary shares is that they create equality across all shareholders and make it easier to divide equity. It can also prevent conflict between shareholders if they believe some are getting preferential treatment.
However, introducing other types of shares can assist in attracting further investment by offering various perks and help you to tailor shareholder relationships to the needs of your business and your investors. Below, we explore how these other types of shares differentiate from ordinary shares.
What are the other types of shares?
If a company chooses to diversify their share offering, this is often referred to as ‘alphabet shares’. Different types of shares will be grouped by letter, such as ‘share A’ and ‘share B’, making it easier to divide and recognise who holds what.
Generally, ‘different shares’ refers to the varying level of rights and entitlements associated with shareholders. Shareholders must agree to the share you are offering and know that this is not the same as other investors in your company.
These are the main areas a share could be differentiated by:
- Entitlement to dividends, ranging from entitlements in specific scenarios, entitlement only after other share classes have received theirs or no entitlement to dividends whatsoever
- Entitlement to capital if a company is dissolved and how it is distributed, with some share classes ranking ‘higher’ and therefore getting their money as a priority
- Voting rights, such as giving some shareholders more votes and therefore increasing their influence on your business decisions
- Permanency – in some cases, companies may have the right to buy back shares from specific holders
These are the most common other types of shares a company can choose to offer, many of which encompass the variation listed above.
Deferred ordinary shares – these are the same as ordinary shares, offering a similar level of rights and entitlements, but the significant difference is that these shareholders only receive dividends once other shareholders have received the minimum amount they are entitled to. So, if a company only makes a limited amount of profit, it is possible deferred ordinary shareholders will not get any dividends if it all goes to ordinary shareholders instead.
Redeemable shares – With these shares, the company has the option of repurchasing them after a set period, usually at the same price they issued at. If you are utilising redeemable shares, you must also have some unredeemable shares that can’t be repurchased. However, it’s a good option if you do not want to commit to long-term shareholders or want to control some of your share dilution.
Preference shares – these shares give certain holders the right to a fixed amount of dividends, which will be received before ordinary shareholders. It’s possible to have different classes here – for example, class A might receive dividends first, then class B, then class C based on what remains.
It’s also possible to combine share types, such as having redeemable preference shares.
Due to the multitude of shares available, it can be confusing to decide the best combination for your business. It’s best to start with just one type of share to make things simpler, but you may choose to introduce other types as you become more comfortable and establish your company’s needs.
Adding different types of shares can also become a helpful tool for incentivising new investors to support your company by allowing them to find a share level that works from their needs and with the option of gaining a higher return or better share price than other shareholders. This can help you to secure a larger pool of funding.
Conclusion
Understanding the various types of shares your company may enable you to create a tailored strategy for your business, addressing your preferences while managing shareholder relationships.
This gives you access to the equity funding you need to run your business long-term while creating agreements that work for all parties and allow continued investment.
If you are considering bringing a shareholder into your business, we can take you through the possible options. We can also put you in touch with relevant contact to kickstart your investment journey.