Issuing shares is a powerful capital generation method that can help startups secure the funding they need to scale — but what’s the difference between ordinary shares and preference shares?
Launching a startup isn’t easy. There are a number of strategies you can use to ensure your startup is set up for success from the start. Even the best startup concepts will fail without adequate funding. Data published by the EU Startup Monitor reveals that over 70 percent of all startups fail due to a lack of adequate funding. One way to get funding is to issue ordinary and preference shares.
There are many different strategies a founder can use to secure funding for a startup concept, such as bootstrapping from personal funds or capturing VC capital via funding rounds. But issuing shares can be a highly effective technique. However, there are several factors that should be considered.
Understanding the difference between ordinary shares and preference shares is critical if you’re considering issuing shares in your enterprise to investors.
An ordinary share issued by a company provides shareholders with the right to vote on matters presented to the shareholders of the company. In most cases, one ordinary share in a company is equivalent to one vote. The weight of a shareholder’s vote is typically dependent on the ownership percentage that they control.
Ordinary shares also provide shareholders to dividends — shareholders have the right to receive a share of the profits generated by a company that they hold ordinary shares in. Whether or not a company provides shareholders with the right to dividends is dependent on the discretion of the issuing company.
Ordinary shareholders will only receive a dividend after the issuing company has paid out all debts, including debts owed to preference shareholders. The amount of the dividend paid out to an ordinary shareholder is dependent on the performance of the issuing company.
- So, if you are looking at ordinary and preference shares, what advantages do preference shares have?
- A preference share is a share issued to shareholders that gives the owner preferential treatment over ordinary shareholders. Preference shares can offer advantages such as:
- Predetermined or fixed dividend payments, or
- A priority right for repayment should the issuing company become insolvent, such as a liquidation priority
In some cases, issuing companies will pay dividends to preference shareholders as a fixed percentage. Shareholders that possess preference shares and fixed dividend rights benefit from a greater level of certainty over their investment — preference shareholders will receive their dividend before shareholders that possess ordinary shares.
Preference shareholders will also benefit from preferential treatment should a company become insolvent. If a company can no longer pay debts, a preference shareholder will be able to recover their investment funds sooner than an ordinary shareholder.
The volatile nature of the startup environment has created an investment ecosystem in which investors considering directing capital toward new startups are more likely to consider investing in preference shares over ordinary shares.
A preference share provides investors with the assurance that the issuing company will reimburse them before ordinary shareholders.