152. All about Stock Exchanges 2 Navya’s Eighth Article

DIFFERENT TYPES OF SHARES

The share capital of a company is divided in to small units. Each being called a share.  A PERSON WHO BUYS A SHARE IS CALLED THE SHARE HOLDER or member of the company. A person can acquire as many shares as are allotted to him by the board of directors.  The share capital forms part of the proprietary or ownership funds and it is used for financing the long term requirements, the fixed capital and the fixed part of regular working capital. It need not be repaid during the life time of the company. The redeemable preference share can however, be repaid during the existence of the company.

Shares represent ownership of a company. When an individual buys shares in your company, they become one of its owners. Shareholders choose who runs a company and are involved in making key decisions, such as whether a business should be sold.

While shares are most obviously associated with the stock market, most small businesses don’t go near a stock market in their lifetime. They are more likely to issue shares in their company in return for a lump sum investment. This investment may either come from friends and family or, for businesses that are looking for capital to fund high growth, through formal equity funding finance.

Formal equity finance is available through:

• business angel investors
• venture capital firms
• stock markets

These investors are willing to put up capital for a share in a growth business. The advantage of raising money in this way is that you don’t have to pay the money back or pay interest to the investors. Instead, shareholders are entitled to a share of the distributable profits of the company, known as dividends.

Types of shares

A company may have many different types of shares that come with different conditions and rights.

There are four main types of shares:

• Ordinary shares are standard shares with no special rights or restrictions. They have the potential to give the highest financial gains, but also have the highest risk. Ordinary shareholders are the last to be paid if the company is wound up.
• Preference shares typically carry a right that gives the holder preferential treatment when annual dividends are distributed to shareholders. Shares in this category receive a fixed dividend, which means that a shareholder would not benefit from an increase in the business’ profits. However, usually they have rights to their dividend ahead of ordinary shareholders if the business is in trouble. Also, where a business is wound up, they are likely to be repaid the par or nominal value of shares ahead of ordinary shareholders.

ADVANTAGES OF PREFERENCE SHARES (From the investor’s point of view)

1. Preferential treatment is given when the dividend is distributed by the company.

2. This type of share is preferred by a cautious investor

3. At the time of winding up of the company the preference shareholders are given a preferential treatment in getting back their capital before all other types of shareholders.

LIMITATIONS OF PREFERENCE SHARES

• Preference share holders cannot attend all the meetings of the company
• Even if the company earns large amount of profits, preference share holders will be given only the fixed rate of dividend.

Cumulative preference shares give holders the right that, if a dividend cannot be paid one year, it will be carried forward to successive years. Dividends on cumulative preference shares must be paid, despite the earning levels of the business, provided the company has distributable profits.  The cumulative preference share holders enjoy the right of accumulation of dividend during the periods of inadequate profit. The share holders get their dividend for the period of loss also.

Redeemable shares come with an agreement that the company can buy them back at a future date – this can be at a fixed date or at the choice of the business. A company cannot issue only redeemable shares. Redeemable preference shares are having a special quality to get the capital before the winding up of the economy. Normally the share holders can get back their capitals at the time of winding up of the company. In the case of redeemable preference shares, the capital must be paid back after an agreed period. All the Redeemable preference shares must be fully paid shares.

SHARE HOLDER

A shareholder is an individual or company (including a corporation) that legally owns one or more shares of stock in a joint stock. Both private and public traded companies have shareholders. Companies listed at the stock market are expected to strive to enhance shareholder value.

Shareholders are granted special privileges depending on the class of stock, including the right to vote on matters such as elections to the, board of directors the right to share in distributions of the company’s income, the right to purchase new shares issued by the company, and the right to a company’s assets during a liquidation of the company. However, shareholder’s rights to a company’s assets are subordinate to the rights of the company’s creditors.

Shareholders are considered by some to be a partial subset of stakeholders, which may include anyone who has a direct or indirect equity interest in the business entity or someone with even a non-pecuniary interest in a nonprofit organization. Thus it might be common to call volunteer contributors to an association stakeholders, even though they are not shareholders.

Although directors and officers of a company are bound by fiduciary duties to act in the best interest of the shareholders, the shareholders themselves normally do not have such duties towards each other.

However, in a few unusual cases, some courts have been willing to imply such a duty between shareholders. For example, in California, USA, majority shareholders of closely held corporations have a duty to not destroy the value of the shares held by minority shareholders.

The largest shareholders (in terms of percentages of companies owned) are often mutual funds, and, especially, passively managed exchange traded funds.

Application

The owners of a private company may want additional capital to invest in new projects within the company. They may also simply wish to reduce their holding, freeing up capital for their own private use. They can achieve these goals by selling shares in the company to the general public, through a sale on a stock exchange. This process is called an initial public offering, or IPO.

By selling shares they can sell part or all of the company to many part-owners. The purchase of one share entitles the owner of that share to literally share in the ownership of the company, a fraction of the decision-making power, and potentially a fraction of the profits, which the company may issue as dividends .In the common case of a publicly traded corporation, where there may be thousands of shareholders, it is impractical to have all of them making the daily decisions required to run a company. Thus, the shareholders will use their shares as votes in the election of members of the board of directors of the company.

In a typical case, each share constitutes one vote. Corporations may, however, issue different classes of shares, which may have different voting rights. Owning the majority of the shares allows other shareholders to be out-voted – effective control rests with the majority shareholder (or shareholders acting in concert). In this way the original owners of the company often still have control of the company

Shareholder rights

Although ownership of 50% of shares does result in 50% ownership of a company, it does not give the shareholder the right to use a company’s building, equipment, materials, or other property. This is because the company is considered a legal person, thus it owns all its assets itself. This is important in areas such as insurance, which must be in the name of the company and not the main shareholder.

In most countries, boards of directors and company managers have a fiduciary responsibility to run the company in the interests of its stockholders. Nonetheless, as Martin Whitman writes:

”It can safely be stated that there does not exist any publicly traded company where management works exclusively in the best interests of OPMI [Outside Passive Minority Investor] stockholders. Instead, there are both “communities of interest” and “conflicts of interest” between stockholders (principal) and management (agent). This conflict is referred to as the principal/agent problem. It would be naive to think that any management would forego management compensation, and management entrenchment, just because some of these management privileges might be perceived as giving rise to a conflict of interest with OPMIs”

Even though the board of directors runs the company, the shareholder has some impact on the company’s policy, as the shareholders elect the board of directors. Each shareholder typically has a percentage of votes equal to the percentage of shares he or she owns. So as long as the shareholders agree that the management (agent) is performing poorly they can elect a new board of directors which can then hire a new management team. In practice, however, genuinely contested board elections are rare. Board candidates are usually nominated by insiders or by the board of the directors themselves, and a considerable amount of stock are held or voted by insiders.

Owning shares does not mean responsibility for liabilities. If a company goes broke and has to default on loans, the shareholders are not liable in any way. However, all money obtained by converting assets into cash will be used to repay loans and other debts first, so that shareholders cannot receive any money unless and until creditors have been paid.

Means of financing

Financing a company through the sale of stock in a company is known as equity financing. Alternatively debt financing (for example issuing bonds) can be done to avoid giving up shares of ownership of the company. Unofficial financing known as trade financing usually provides the major part of a company’s working capital (day-to-day operational needs).

Questions

1. How are shares issued?

2. What do you say about Sale and transfer of shares?

3. Write a note on paying dividends and paying tax ?