Common shares and preference shares

What do common shareholders own?

Common shares are the basic ownership claim on a company. Holders have a residual claim : they are paid only after creditors and preference shareholders, so they get whatever is left. In good years that can be a lot. In a failure it can be nothing.

Three things define the holder’s position.

• Dividends are paid at the board’s discretion. There is no promise, and they can rise or fall with profits.
• Votes on the board and big decisions normally come with the shares.
• Limited liability means the most a holder can lose is what the shares cost.

Some companies issue several share classes , each with different rights. A common pattern is founders’ shares carrying 10 votes each next to public shares carrying one. The classes can also differ in dividend claims. Extra votes give insiders control out of proportion to their money, which is why investors treat unequal voting as a governance risk.

Equity securitiesownership claims on a company

• Common shares Memorize residual claim, votes, highest risk and upside
  • Voting rule statutory or cumulative
  • Share classes different votes or dividend claims
  • Callable or putable issuer buys back, or holder sells back
• Preference shares Memorize fixed dividend first, priority in liquidation, usually no vote
  • Dividend history cumulative or non-cumulative
  • Profit sharing participating or non-participating
  • Other options convertible, callable, putable

How does voting work?

Under statutory voting , a holder gets one vote per share for each seat up for election and may use at most that many votes on any one candidate. Under cumulative voting , the holder instead gets shares × seats votes in one pool and may put all of them on a single candidate, or split them as they like.

$$V = S \times K$$

The benefit goes to small holders. By concentrating their votes they can win a seat that a statutory count would give to the majority. Voting by proxy is a separate matter: a vote by proxy means an appointed party casts the holder’s vote, usually at the annual meeting. It changes who votes, not how votes are counted.

Go deeper How many shares guarantee a seat?

With cumulative voting, a block of shares wins one seat when it holds more than a fraction 1 ÷ (seats + 1) of all shares. With 4 seats that is just over one share in five.

$$S > \frac{N}{K + 1}$$

Check with 1,000 shares and 4 seats. A holder of 201 shares has 804 votes. The other 799 shares carry 3,196 votes in total, and even if they split perfectly over four candidates each gets 799, below 804. At exactly 200 shares the holder has 800 votes and the rivals can tie at 800 each, so the seat is not guaranteed.

Under statutory voting there is no such protection: more than half the shares wins every seat.

What are preference shares?

Preference shares (also called preferred stock) rank above common shares for dividends and for assets in a liquidation, but behind debt. The dividend is fixed, usually a percentage of par (face) value and usually higher than a common dividend. Holders generally do not vote and do not share in the company’s growth, unless the terms say otherwise.

They mix features of bonds and common shares. Like a bond, the dividend is fixed and they can be perpetual. Unlike a bond, the dividend is not a contractual obligation, so missing it is not a default.

Which features change a preference share?

Preference shares are customized through a handful of features. Each moves the balance between holder and issuer.

Preference share featuresmix and match: for example cumulative and participating

• Dividend history Memorize what happens to a missed dividend
  • Cumulative Memorize accrues, paid before any common dividend
  • Non-cumulative Memorize lost for good
• Profit sharing Memorize what happens when profits are high
  • Participating Memorize fixed dividend plus extra when profits pass a set level
  • Non-participating fixed dividend and par only
• Options who can change the deal
  • Convertible Memorize holder can switch into common
  • Callable issuer can redeem
  • Putable holder can sell back

Cumulative or not. On cumulative preference shares , a missed dividend accrues and must be paid in full before any common dividend. The unpaid amount is called dividends in arrears . On non-cumulative preference shares , a missed dividend is gone for good. The company still may not pay common holders until the current preference dividend is paid, but it owes nothing for the past.

$$D = (n + 1) \times r \times \text{par}$$

Participating or not. Participating preference shares pay the standard dividend plus an extra amount when profits pass a set level. Some also give a share of liquidation proceeds above par. Non-participating preference shares pay only the fixed dividend and par in a liquidation. Participating shares are more common in small, risky companies, where holders worry about a liquidation.

Convertible. Convertible preference shares can be exchanged for a fixed number of common shares, set when they are issued. The holder keeps a steady dividend, usually higher than the common one, and can still gain if the common price rises. The price is also steadier than the common’s. They are popular where the issuer is young and risky, and a listing may be years away.

Exam tip Cumulative voting and cumulative preference sound alike. The first is about counting votes for directors. The second is about dividends owed.

How do call and put features change the risk?

Callable common shares let the issuer buy the shares back at a set price. That is good for the issuer and bad for the holder, who loses the shares just when they are doing well. Putable common shares let the holder sell the shares back at a set price. The put puts a floor under the price, so the holder carries less risk and typically accepts a lower dividend in return.

The same logic applies to preference shares. The simple rule: an option held by the investor lowers the investor’s risk, and an option held by the issuer raises it. Lesson 4 turns this into a full risk ranking.

Go deeper Why participating preference appears in venture deals

A start-up has high odds of failing and a small chance of a huge win. Investors who put in cash want two things: money back first if it fails, and a share of the upside if it succeeds. Participating, often convertible, preference shares do both. They rank ahead of the founders’ common shares in a liquidation and also share in the surplus. That is why you meet them in private deals more than in listed markets.

Go deeper Dual-class listings and index rules

Some listed companies keep a class of high-vote shares for founders. Index providers differ in how they treat them: some exclude companies with limited public votes, some include them but at a reduced weight. For an investor the practical point is that a low-vote or no-vote share can trade at a discount to a full-vote share of the same company, because it carries no say over control.