Differences Between Preference Shares and Ordinary Shares

 

When setting up a company or investing in one, understanding the types of shares available is critical. The two primary types of shares—preference shares and ordinary shares—have unique features, advantages, and limitations. In this article, we will comprehensively explore the differences between preference shares and ordinary shares to guide you in making informed financial and corporate decisions.

 

 

What Are Shares?

 

Shares represent a unit of ownership in a company. By owning shares, an individual becomes a shareholder, with rights to a portion of the company’s profits and assets. Shares are categorized broadly into preference shares and ordinary shares, each catering to different investor needs and corporate objectives.

 

 

What Are Preference Shares?

 

Preference shares, also called preferred stock, are a class of shares that give shareholders preferential rights over ordinary shareholders in certain aspects, such as:

 

1. Dividend Payment: Preference shareholders receive dividends before ordinary shareholders.

 

2. Repayment in Case of Liquidation: They are prioritized when the company distributes assets during liquidation.

 

3. Fixed Dividend Rate: Typically, preference shares have a fixed dividend rate, making them less risky than ordinary shares.

 

 

Types of Preference Shares

 

1. Cumulative Preference Shares: Dividends accumulate if not paid in a particular year.

 

2. Non-Cumulative Preference Shares: Dividends are not carried forward if unpaid.

 

3. Participating Preference Shares: Shareholders participate in additional profits after ordinary shareholders receive dividends.

 

4. Convertible Preference Shares: Can be converted into ordinary shares after a specific period.

 

5. Redeemable Preference Shares: Can be redeemed by the company after a set time.

 

 

What Are Ordinary Shares?

 

Ordinary shares, also known as common stock, represent the majority of shares issued by a company. Holders of ordinary shares are the true owners of the company and enjoy rights such as voting in general meetings. However, they take on higher risks compared to preference shareholders.

 

 

Key Characteristics of Ordinary Shares

 

1. Variable Dividends: Dividend payments depend on the company’s profitability.

 

2. Voting Rights: Ordinary shareholders typically have voting rights, giving them a say in corporate decisions.

 

3. Residual Claims: In the event of liquidation, they are paid after preference shareholders.

 

 

Key Differences Between Preference Shares and Ordinary Shares

 

Aspect	Preference Shares	Ordinary Shares
Dividend Rights	Receive fixed dividends before ordinary shareholders.	Receive dividends only after preference shareholders.
Voting Rights	Usually do not carry voting rights.	Typically carry voting rights.
Risk Level	Lower risk due to fixed dividends and priority in assets.	Higher risk as dividends and assets are not guaranteed.
Liquidation Priority	Priority claim over the company’s assets during liquidation.	Residual claim after preference shareholders.
Dividend Rate	Fixed or predetermined.	Variable and dependent on company profits.
Convertibility	Can sometimes be converted into ordinary shares.	Cannot be converted into preference shares.

 

 

Advantages and Disadvantages of Preference Shares

 

Advantages:

 

1. Stable Income: Fixed dividend rates provide consistent income.

 

2. Lower Risk: Priority in dividends and liquidation reduces investment risks.

 

3. Convertible Option: Convertible preference shares offer flexibility.

 

 

Disadvantages:

 

1. Limited Growth: Fixed dividends mean preference shareholders miss out on extra profits.

 

2. No Voting Rights: Shareholders have limited influence on corporate decisions.

 

 

Advantages and Disadvantages of Ordinary Shares

 

Advantages:

 

1. Potential for High Returns: Dividends can grow with company profitability.

 

2. Voting Power: Shareholders have a say in corporate governance.

 

3. Residual Profit Claims: Shareholders enjoy all profits after obligations are met.

 

 

Disadvantages:

 

1. Higher Risk: Dividends and liquidation payments are not guaranteed.

 

2. Volatility: Share prices can fluctuate significantly.

 

 

Which Type of Share is Right for You?

 

Investors Seeking Stability: Preference shares are ideal for investors who prioritize stable returns over voting rights and capital growth.

 

Investors Seeking Growth and Control: Ordinary shares suit those willing to take risks for potentially higher returns and corporate influence.

 

 

Legal Framework for Shares in Nigeria

 

In Nigeria, the Companies and Allied Matters Act (CAMA) 2020 governs the issuance of preference and ordinary shares. Companies must

 

 

Tax Implications of Shares in Nigeria

 

Dividend income from both preference and ordinary shares is subject to Withholding Tax (WHT), currently at 10% for Nigerian residents. Understanding the tax implications is crucial when investing in shares.

 

 

Conclusion

 

The choice between preference shares and ordinary shares depends on your investment objectives, risk appetite, and desire for involvement in corporate decisions. While preference shares offer stability and lower risk, ordinary shares promise higher returns and voting rights.

 

For businesses, deciding on the type of shares to issue depends on your capital structure and long-term objectives. Need help deciding or issuing shares? Contact our team for expert advice on corporate structure and compliance.

 

 

Optimize Your Corporate Investments with Us!

 

Are you looking to incorporate a company or understand shareholding structures in Nigeria? Visit our website, CACregistration.com, for expert services in business registration, corporate compliance, and beyond.