TYPES OF SHARES

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INTRODUCTION

The Capital of a Company is divided into specified numbers of equal units known as “Shares”. According to Section 2(84) of the Companies Act, 2013 (Hereinafter “The Act”), “Share” means a share in the share capital of a company and it includes stock as well. It represents a shareholder’s stake of ownership in Company’s capital. As per Sec. 44 shares are movable property transferable in the manner provided by the articles of the company. Hence, a Share is a transferable interest of shareholders which carries certain rights & liabilities while the company is a going concern and, in its winding, up.[1] The Memorandum & Articles of Association prescribe the rights & duties of Shareholders.

As per Sec. 43 of the Act, Share Capital of a Company limited by Shares is divided into two types i.e., Equity Share Capital & Preference share Capital. This division is based on the risk associated, rights & obligations of subscribers of the said type of shares.

PREFERENCE SHARES

Preference share Capital as defined by explanation under Section 43 means that part of Share capital which is raised by issuing preference shares & carries preferential rights with respect to dividend & repayment rights (at the time of winding up) over equity shares i.e., the dividend is pre-determined at certain rate & priority repayment, over equity shareholders is given to preference shareholders when a Company is winding up.

Further, if dividend on preference shares has not been paid by the Company for a period of two years or more, such shareholders have the right to vote on all the resolutions placed before the Company.

Characteristics

  • Hybrid of stock & bond: Preference shares carry the features of both equity & debt; thus, they are hybrid form of investment.
  • Dividends: Preference shares carry a pre-determined rate of dividend & enjoy priority over Equity Shares in payment of dividend. If the shares are cumulative in nature, then any dividend not paid by nature, then any dividend not paid by Company in any previous year accumulates & is paid in future. But in case of Non-cumulative it does not get accumulated & this right cannot be enjoyed.
  • Right to vote: Generally, preference shares do not carry right to vote except in special circumstances. For Eg. In case of non-payment of dividend for past two years or more. They do not carry any right to participate in management per se.
  • Redeemable: Redeemable Preference shares have a maturity date. Hence, Company has to repay the amount invested by Shareholder after the expiry of maturity period. While in case of Non-Redeemable preference shares, the invested amount cannot be claimed until liquidation of the Company.
  • Less Risky: As compared to Equity shares, preference shares bear lesser risk as they are entitled to fixed dividend & priority of repayment at the time of liquidation.
  • Right on Assets: Preference Shareholders enjoy priority over equity holders at the time of Liquidation. It means that their Company’ assets are first used to satisfy the claims of Preference shareholders’ and then Equity holders’.
  • Preemptive Rights: It means that Shareholders enjoy the right of receiving further issues from the Company before it is made offered to the Public.
  • Convertibility of Shares: If the shares are issued with convertibility clause, they are entitled to be converted into equity shares after the fulfilment of required conditions.

Types of Preference Shares

  • Cumulative & Non-cumulative: When dividends are accumulated, including those that were omitted in the past & paid before equity shareholders, are known as Cumulative Preference Shares.

While, non-cumulative preference shareholders cannot claim any accumulated dividends at any time in future, if company omits or chooses not to pay dividends in any given year.

  • Convertible & Non-convertible: Convertible preference shares are those shares where its holder can exercise the option of converting said shares into an ordinary equity shares provided certain terms & conditions are fulfilled. Non-convertible preference shareholders do not enjoy this option of conversion of their shares into equity shares.
  • Participating & Non-participating: When Preference shareholder has an additional benefit of participating in “Surplus profit” or “Surplus Assets” of the company apart from preferential dividend declared by the Company. In Non-participating preference shares the holder does not enjoy any extra benefits pertaining to profit or assets of Company other than pre-determined preferential dividend.
  • Redeemable & Non-redeemable: Preference shares which are issued on the condition of redemption i.e., Company pays the capital amount invested by shareholder after maturity date are called Redeemable preference shares. On the other hand, those preference shares which do not have any maturity date & are repayable only at the time of winding up of Company are called Non-redeemable preference shares. A Company can only issue redeemable preference shares & not irredeemable preference shares. Hence, Company has to redeem Preference shares within a period of twenty years & in case of infrastructure company within thirty years[2].

Advantages

  1. Prior claim on Business assets is enjoyed by Preference shareholders in case of liquidation.
  2. A pre-determined rate of Dividend is carried by them & priority of payment of dividend over equity shareholders is also enjoyed by its holders.
  3. Less risk is borne by Preference shareholders.
  4. Shares have to be redeemed by the Company after the maturity period.
  5. If convertible, then shareholder can convert it into equity shares.
  6. They are convenient to raise as unlike debentures no charge on assets is created.

Disadvantages

  1. They do not carry voting rights unless required by statute or Articles of Association.
  2. Preference shares carry higher rate of dividend than Debenture interest & the accumulation of preferential dividend in case of cumulative shares, makes it a permanent burden on Company
  3. Sometimes, company has to use available profit to pay preferential dividend, instead of using it for other productive purpose.
  4.  The Preferential dividend is not entitled to be deducted for income tax purpose.
  5. They more expensive than equity shares.

EQUITY SHARES

In case of Company limited by shares, Equity shares as those shares which are not preference shares[3] i.e., which do not carry any guaranteed amount of dividend but carries voting rights. They are also referred as “Common stock” or “Common share Capital”, as they also represent the ownership of a Company. Its holders are called “Equity shareholders” & they are considered the real owners or policymakers of the Company. The Board of Directors are appointed by them to look after the daily affairs of the Company.

Every equity shareholder enjoys the right to vote on every resolution placed before the company & his voting right on the poll is considered in proportion to his share in the paid -up share capital of the Company.[4] Section 43, provides for two types of equity shares i.e., with Voting rights & with differential voting rights. Equity shares with Differential Voting Rights (DVRs) are with respect to voting, dividend or in accordance with such rules as may be prescribed.

Characteristics

  1. Right to Vote: Equity shares carry right to vote & participate in every decision of management. The right to vote is limited to the proportion of shares subscribed by shareholder. They can also carry differential voting rights as the case maybe.
  • Right over surplus profit: Equity Shareholders can claim right over the surplus profit remaining with the Company in a financial year.
  • High Risk: Its holders have to bear higher risk than any other class of investors as there is no guarantee of yearly dividend & their right over asset is considered only after the settlement of interests of all other investors.
  • Owner of Company: Equity Shareholders are the real owners of the Company; hence, they can participate in all the meetings of the Company’s members & can vote & participate in managerial decision making.
  • Transferable: The shares are easily transferrable, as provided by the Act & Articles of Company.
  • Maturity Period: They do not carry any maturity date, thus, for the Company it is a perpetual source of capital until liquidation.
  • Liquidation: At the time of winding up Equity shareholders are paid at end if any amount is left after satisfying the rights of preference shareholders, debentures & other creditors.

Advantages

  1. Equity shares are highly liquid, hence, can be easily sold in Capital Market.
  2. Equity shareholder are entitled to claim extra dividends in case of surplus profits.
  3. Liability is limited to the remaining amount not paid towards the shares.
  4. Its holder enjoys right to vote & participation in decision making of a Company.
  5. Shareholder’s enjoy privilege to have priority in purchasing shares in case of further public issue of shares as a matter of right (Right Issue). They are also entitled to receive bonus shares without any extra payments.
  6. From Company’s viewpoint it is a permanent source of Capital & does not bear obligation of repayment (except in case of Liquidation).
  7. No pre-determined or compulsory payment of dividend is required to is Holder.
  8. Large equity Capital base increases creditworthiness of Company among lenders & borrowers.

Disadvantages

  1. Equity shareholders are entitled to dividend only if the profit remains after Debenture Interest payments, preference dividends, taxes etc. Thus, no guarantee of return on investment & they cannot claim dividend in the future.
  2. The rate of dividend is always fluctuating, hence, no steady return on investment.
  3. Equity Shareholder’s claim is considered at the end, in case of liquidation.
  4. Being the owners of the Company, equity shareholders have to bear greater risk than any other kind of investors.
  5. Equity shares are irredeemable i.e., cannot be redeemed during the lifetime of the Company.

CONCLUSION

It can be summed up that, it is the Company requirements, future perspectives & projects undertaken which play crucial role in determining the type of share capital or debt, it is willing to raise. Similarly, investor’s ability to bear risk & expectation of return on investment which play crucial role in determining his interests & choice of investment.


[1] Halsbury’s law of England, Volume V, pp. 171

[2]The Companies Act, 2013, §55.

[3] The Companies Act, 2013, explanation to §43.

[4] The Companies Act, 2013, §47.

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