Ordinary shares are basic shares that allow shareholders to vote on the company’s issues and to receive dividends. They are also known as equity shares or common shares.
Let’s define the ordinary shareholders’ rights, discover why to invest in ordinary shares, and how to choose between ordinary and preference shares.
Before we do, let us go a little off topic. Osome provides no nonsense accounting services for SMEs. If you need help with you books, check it out.
How to define ordinary shares?
Obtaining an ordinary share is a way to invest in or to get control of a company. Ordinary shareholders are equity owners of the company and they hold certain rights:
- Voting. Usually, an ordinary share equals one vote. So, the more ordinary shares a shareholder possesses, the greater say they have during the shareholders’ meetings. For example, their opinion will influence the approval of the company’s policies, the board members and annual financial statements.
- Receiving dividends. Ordinary shares provide shareholders with the right to participate in dividing the company’s profit. But the company can distribute dividends to ordinary shareholders only after paying all the debts and dividends to preferred shareholders (see below).
- Receiving pay ups in case of insolvency. If the company goes bankrupt, ordinary shareholders can expect to save their assets — but again, they are the last in line for payments. All the creditors and preference shareholders have the advantage here. The ordinary shareholders are usually left with nothing.
Ordinary shares are issued when the company is incorporated. But later, the company can open shares to the public an issue new stock or the owners can sell their shares on the stock exchange. The total amount of money the company raised through the sale of the shares is called share capital.
Note, that if the company’s owners are looking to attract investments but want to keep majority control of the company, they can issue non-voting ordinary shares. These shareholders don’t participate in the meetings but get dividends.
What is the ordinary shares’ advantage?
While ordinary shareholders are the last to receive dividends and take more financial risk, they can also gain more profit. Even if the company performs well, preference shareholders still receive fixed amounts. Meanwhile, ordinary shareholders divide the rest of the large company’s profit between themselves. But have in mind that the dividends are still not fully guaranteed for both share types: the majority of the shareholders can decide not to distribute the profit at all and to keep it for the company’s needs.
Ordinary shareholders have no obligations except for paying the price of the shares upon their issue or purchase on the stock exchange.
At worst, if the company declares itself bankrupt, ordinary shareholders lose only their investments. They do not have to pay for the company’s debts.
What is the difference between ordinary and preference shares?
Ordinary and preference shares both represent ownership in the company but offer different rights to the shareholders. Let’s take a look at the scheme to see the distinction:
Preference shareholders are more secure and have more certainty over their investments, while ordinary shares grant more control over the company and can result in more profit.
Investors usually choose preference shares for startups to ensure their stable income. On the other side, a purchase of ordinary shares in a startup is a risky investment but one can hit the jackpot.
Imagine in 1980 you invested in Apple $22 per share when the company opened the stock to the public. For the last 30 years, the stock split four times. It means that one share turned into 56 shares. By the end of January 2020, the cost of the shares increased 14 times and reached $311 per share. So, now you would have about $17,416 ($311x56) per share. And we don’t count dividends.
Note that shareholders must pay taxes over certain amounts of dividends, so it can reduce factual revenue. The UK Government gives instructions on the dividends tax payments.
Above, we described the common practice. But keep in mind that every rule has its exceptions. In specific cases, ordinary shares might go without voting right and preference shares might vote. So, the company can impose additional restrictions on the shares.
- Ordinary shareholders own the company.
- Ordinary shares grant the right to vote in the shareholders’ meetings, to get dividends and to be paid if the company goes bankrupt.
- Dividends of the ordinary shareholders are not fixed and depend on the company’s performance.
- Preference shareholders do not vote, have fixed dividend rates and paid first in the case of insolvency.
- Ordinary shares are worth a long term investment while preference shares are more secure and predictable.
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