In the realm of corporate finance, understanding the intricacies of share types is paramount for both companies seeking capital and investors looking to deploy their funds effectively. In Malaysia, the issuance of shares by companies is regulated under Section 69 of the Companies Act 2016 (‘CA 2016’). Generally, companies can issue two types of shares – Ordinary Shares and Preference Shares, each conferring different rights to its holders. Whether you are interested in establishing or investing in a company, gaining insight into the realm of share types becomes invaluable.
This article delves into the nuances of Ordinary and Preference Shares, exploring their characteristics, rights, and implications for investors and companies alike. By elucidating these differences, stakeholders can make informed decisions tailored to their financial objectives and risk preferences.
Ordinary Shares
Ordinary Shares, often referred to as Common Shares, constitute the most frequently issued type of shares and are commonly regarded as equity investments. Holders of Ordinary Shares enjoy voting rights and active participation in the company’s earnings and growth.
Preference Shares
Preference Shares represent a unique security combining features of both debt and equity. Unlike Ordinary Shares, Preference Shares under Section 2(1) of the CA 2016 do not have voting rights. However, the Companies Commission of Malaysia’s FAQ clarifies that Preference shareholders might possess certain voting rights concerning their share class if expressly set out in the constitution.
Preference Shares come with several features, including:
1. Cumulative / Non-Cumulative:
A cumulative Preference Share allows the holder to receive dividends, which accrue if unpaid due to insufficient profits until profitability allows. Generally assumed to be cumulative unless otherwise specified in the Company's Constitution.
2. Participative / Non-Participative:
Preference Shares are generally considered non-participative unless specified otherwise in the company's constitution. If specified, the holder is entitled to a designated dividend rate and may participate in further distributions from surplus profits.
3. Redeemable / Non-Redeemable:
Redeemable Preference Shares are issued by companies with future redemption options, subject to the company’s constitution and the requirements of Section 72 of the CA 2016.
4. Convertible / Non-Convertible:
Convertible Preference Shares are issued with the right to convert into Ordinary Shares at a predetermined rate and timeframe, providing flexibility for shareholders.
Key Differences and Implications between Ordinary and Preference Shares:
I. Dividend Preference:
● Preference Shares: Holders are entitled to a fixed rate of dividends as specified in the company’s constitution, with priority in receiving dividends before ordinary shareholders.
Advantage: Provides a consistent income stream. Disadvantage: Fixed rate may limit potential for higher dividends during prosperous times.
● Ordinary Shares: Dividends are variable and fluctuate based on company performance, distributed after preference shareholders are paid.
Advantage: Potential for increased dividends during periods of company prosperity. Disadvantage: Vulnerable to market volatility and potential for lower dividends during downturns.
II. Voting Rights:
● Preference Shares: Generally have no voting rights unless specified in the company's constitution.
Advantage: Investors can avoid direct involvement in management decisions. Disadvantage: Limited influence over company decisions.
● Ordinary Shares: Typically come with voting rights, allowing shareholders to participate in company decisions.
Advantage: Active involvement in crucial company decisions. Disadvantage: Potential for conflicts among diverse shareholders and dilution of control.
III. Asset Distribution on Liquidation:
● Preference Shares: Holders have priority claim on assets during liquidation, but payments are made after secured creditors.
Advantage: Lower risk due to higher likelihood of repayment in case of liquidation. Disadvantage: Payments made after secured creditors are satisfied.
● Ordinary Shares: Holders have lower priority compared to preference shareholders in asset distribution during liquidation.
Advantage: Loss is limited to the portion already invested. Disadvantage: Lower claim on assets compared to preference shareholders.
IV. Participation in Surplus Assets and Profits upon Winding Up:
● Preference Shares: Generally have no right to participate unless expressly stated in the company’s constitution.
Advantage: Right to participate if expressly stated. Disadvantage: Complexity in managing surplus assets.
● Ordinary Shares: Entitled to participate in the distribution of surplus assets and profits upon winding up.
Advantage: Provides a simple and accessible option for a broad investor base. Disadvantage: Limited flexibility compared to preference shares.
Conclusion
In conclusion, the choice between Ordinary and Preference Shares depends on an investor's risk tolerance, investment goals, and the company's financial structure. Ordinary Shares provide voting rights and the potential for higher returns, albeit with greater volatility. Investors seeking active participation and growth potential may find Ordinary Shares appealing.
On the other hand, Preference Shares offer stability, priority in dividends, and lower risk, making them suitable for investors prioritizing consistent income streams and capital preservation. Ultimately, the decision between Ordinary and Preference Shares hinges on aligning the investment strategy with individual financial goals and risk preferences.