Shares are considered units of equity ownership in a business corporation. When owners establish a corporation, they may decide to issue shares to investors as a method of collecting capital. These shares can be ordinary shares or preference shares. The raised capital from issuing equity shares is used for operations and growth of the business corporation.
Many businesses consider the issued shares as a financial asset that equally distributes its declared residual profits among the shares in the form of dividends. If the shares are issued with a condition to not pay any dividend, those shareholders do not participate in the profit distribution of the company. Instead, they expect the security of the money invested in shares and the growth of share price with the increase of company profits.
There are two main types of shares often issued by businesses.
01. Ordinary shares – These shares are also known as common shares.
02. Preference Shares
Even though the debt capital obtained by loans or issuing bonds has a legal mandate to repay the owners, equity has no such legal mandate to repay the investors. The company may pay dividends to the investors as a method of distributing the profits. However, it does not pay interest to the investors.
Shares of private limited companies or partnership businesses are privately held by the owners, founders of the partners of the business. If the company continues to grow and decides to collect more capital to cater to the growth of the business, it can get listed on a stock exchange as a public limited company and seek capital by selling the shares to the public via an initial public offering (IPO). After an IPO, the shares of the company can be purchased and sold to the general public.
Ordinary Shares
These are the most common type of shares issued by businesses. These provide shareholders the possibility of residual claim on the profits of the company, providing potential growth in investments through both capital gains and dividends.
Ordinary shares come with voting rights, providing shareholders the control to cast their vote in a company’s decision-making situations such as electing members to the board of directors, approving payments, approving dividends, or issuing new securities. In simple terms, voting rights in ordinary shares give the power to the shareholder to create an impact on the decision-making process of the business.
Apart from that, certain ordinary shares provide preemptive rights to the shareholders, ensuring that the shareholders have the opportunity to buy new shares and retain their percentage of ownership when the business issues new shares.
Preference Shares
Compared to ordinary shares, preference shares have several differences. They do not offer much market appreciation in value ad ordinary shares. Apart from that preference shares do not have voting rights in the corporation. However, investing in preference shares is considered as much safer than investing in ordinary shares as preference shares take priority over ordinary shares if the business files for bankruptcy. In a situation like that, the business is forced to repay its lenders and preference shareholders prior to paying ordinary shareholders but after bondholders. The payments of dividends in preference shares are paid out regularly according to set criteria.
The number of shares that may be issued by the board of directors of the company is known as authorized shares. Out of the authorized shares, the number of shares that are given to the shareholders of the company for the purpose of ownership is known as issued shares.
Since the ownership of the shareholders can be affected by the number of authorized shares, shareholders may limit that number as they see appropriate. When the shareholders are in need of increasing the number of authorized shares, they discuss the issue and establish an agreement by conducting a meeting. Once the agreement is made, a formal request is made to the state by filing articles of amendment.