Now you are ready to realise your entrepreneurial dream, the first step is to decide on your shareholding structure for the owners so that you can incorporate a company.
When it comes to the allocation of shares, you may have questions on the different types of shares and whether to issue ordinary shares or preference shares.
Not sure what it’s all about? Here, we explain the in’s and out’s to help you navigate this particular aspect of setting up your company.
Why is Shareholding Important?
Essentially, shares are a tool to determine the ownership stake of an individual/individuals, a corporate body, or other institution in a particular company.
In short, the shareholders are the ultimate “owners” who will share in the rewards when the company makes money but are also the ones to bear the losses if the company is not doing so well.
The company directors may give presentations to the Board on company strategy or talk about the company’s future plans to the media. Yet it is the shareholders that ultimately would decide whether to accept, amend, or reject such proposals.
For the shareholders of public listed companies, they can attend the Annual General Meeting (AGM), scrutinise the Annual Report, and raise queries with the Board of Directors.
But for the shareholders of private companies, they may not necessarily need to attend the AGM. Instead, the shareholders can achieve a decision via written resolution.
Any shareholder who holds at least five percent of the voting rights (or any lower percentage set out in the constitution) may compel the company to circulate a written resolution for the shareholders to decide on.
However, not all shareholders can exercise voting rights or enjoy similar treatment. We will explore this further under ordinary share vs preferential share.
The majority of most company shareholding structures are constituted with ordinary shares. With ordinary shares, the shareholders are entitled to enjoy the following rights as per Section 71 of the Companies Act 2016:
- attend, participate and speak at a meeting
- vote on a show of hands on any resolution of the company
- one vote for each share on a poll on any resolution of the company
- an equal share in the distribution of the surplus assets of the company, or
- an equal share in any dividends payable.
In essence, the ordinary share offers equity for its holders. By virtue of their ownership, they can also appoint or remove the directors and auditors.
As powerful as it may seem, ordinary shareholders are in fact exposed to risk with regards to the company performance.
In the event of the company becoming insolvent, the ordinary shareholders will be the last to receive any payment, after paying costs, wages, statutory contributions, taxes, creditors, and preferential shareholders.
The ordinary shareholders may, in fact, bear the biggest brunt after the company winding-up.
From the company’s perspective, it can raise more capital by issuing additional ordinary shares. However, such a move may dilute the value of the existing shares.
So how to raise the required capital without sparking dissatisfaction or dissent from current shareholders or accepting much stricter terms and conditions of loans and bonds?
Preferential shares are one of the cards on hand.
At first glance, preferential shareholders may appear to be VVIPs who enjoy much greater privilege than ordinary stockholders. However, this is not the case.
In a nutshell, a preferential share is a “loan” provided by shareholders in exchange for equity in a company. Preferential shareholders do however enjoy higher dividends, whether fixed or adjustable subject to terms and conditions.
Preferential shareholders may even have priority to claim the assets upon the winding-up before ordinary shareholders.
Such instruments are usually well-received by conservative investors as they offer better returns. A preferential share may also be converted into an ordinary share.
However, preferential shareholders do not have voting rights at the company’s AGM.
Why would a company issue preferential shares rather than taking out a bond or loan, or even instead of issuing more ordinary shares?
From the company’s point of view, bonds and loans are fixed obligations. It might be feasible to fulfill the terms of such an obligation during good times. But company cash flow may be tight during more challenging times.
In these situations, as a company, you can decide to defer payment of any fixed dividend to preferential shareholders until the circumstances ease, subject of course to any agreed terms.
Quadrant Biz Solutions can help guide you on these matters and ensure a seamless and fast process with your company incorporation. Contact us today to learn more.