A COMPANY MAY HAVE different classes of common and preferred stock. For example, they are called Class A, B, C and so on. The classes may differ in a number of ways. There may be differences among classes in terms of the following:
• Rights to vote and to have a say in major policy decisions of the company as may arise at a shareholders’ meeting;
• Relative ranking of certain rights as compared to another class or type of shares;
• Restriction on who may own that class of stock;
• Rights to dividend payments and amount of the dividend payment;
• The prevailing market price may differ; rights to redemption; rights to conversion; and,
• Rights to claims of the property, or the liquidation proceeds of the company.
By nature, preferred stockholders do not have any right to a say in the day-to-day operations of the business. Preferred stock simulates the nature of debt in the capital structure of a company.
The company’s articles of incorporation will typically spell out the rights, privileges and restriction of each type and class of shares. In addition, any prospectus for the issuance of new shares presents these details and investors should carefully observe these differences.
For example, consider a local prospectus which offered the general public the opportunity to acquire three million common shares at a price of $1 each. The prospectus also revealed that the company had subscribed for and has been allotted 1.5 million common shares at a price of $1 each. In addition, the company had subscribed for and has been allotted 4 500 two per cent cumulative preferred shares at a price of $1 000 each.
The company had already subscribed and committed to providing $7.5 million in cash arising from common ($3 million) and preferred ($4.5 million) stock for its start-up. It was seeking another $3 million in cash for common stock from the general public.
Say that you had bought 1 000 shares at $1 each. That money ($1 000) would go into the company’s bank account and you would own the pro rata (1/10 500) share of the company. The value of your shares will then depend on the future prospects of the company and how other possible investors view ownership of those shares. Earnings may come from dividend payments and from the actual or potential sale of your shares to another investor at a higher amount than your cost of buying them.
It is possible that this start-up company operated for a number of years without being in a position to pay any dividends. Then, whenever it first paid dividends, the preferred shareholders would have been be paid in full for all the past years before the common shareholders could have been paid for that particular year.
Another example is a prospectus for a public offering which presents two different classes of new common shares: Class A and Class B.
The Class A shares may be made available to the general public. The public then may have the right to dividend payments, have limited voting rights, and those shares may be ranked after the Class B shares in term of claims on the company’s property.
By contrast, holders of the Class B shares may only be the managers of the company who may have wider voting rights (including one vote per share) and rank before the Class A shares in term of claims on certain intellectual property and special assets of the company.
With a better understanding of these different types of share capital and different classes of the shares, investors will be in a better position to make informed choices.
With the support of professional advice, would-be shareholders can ensure that they match their choice of common or preferred stock in any company with their willingness to undertake the related risks.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.
