Share is a document that represents a unit of ownership of the company in the hands of shareholder. In short, the shareholder has right of ownership to a certain extent determined in relation to total number of shares and shares held by the share holder. However, ownership right must not be confused with management right or control of the company.
Shares can be classified in several ways on the basis of their characteristics such as:
Based on preference:
- Preference shares: This type of share gives the holders added facility in terms of distribution of profit in the course of business and distribution of assets at the event of liquidation of company. “Preference” implies that whenever there is distribution of profits/assets then these holders have the first right to receive such profits/assets and thus preferred over ordinary shareholders. Not necessarily every company has such shares. However, preference is only in terms of distribution most of the time (unless terms and conditions of share issue state otherwise).
- Ordinary shares: These shares gives the holder equal rights among other ordinary shareholders. Most of the time holders of such share also have voting rights that give them the power to vote in entity’s general meetings. For each ordinary share held the holder has one vote. The name “ordinary” is given rank it against “preference” shares.
Mainly these are the only two types of shares we have and all the other types of shares are basically sub-classifications of either of these two. For examples redeemable and irredeemable (usually) are two classifications of preference shares.
Similarly ordinary shares may have voting rights or not depending the terms of share issue. This is usually the case with ordinary shares issued to employees as benefits that usually have no voting rights.
Based on voting rights:
- voting shares: Normally every ordinary share has the voting right of 1 vote for every 1 share held. By voting means to vote at entity’s general meeting not in board of director’s meeting as these two meetings are different. Preference shares normally carry no voting rights.
However, its not necessary that every ordinary share voting and every preference share is non-voting.
- non-voting shares: Preference shares are normally non-voting and under certain circumstances ordinary shares also. For example ordinary shares issued to creditors as a settlement of loan. Voting right and right to receive dividend are two different things. Share might not have a voting right but still the holder has the right to receive dividend.
Based on redemption
- Redeemable shares: Type of shares that will be taken back (redeemed) by the company after a certain period of time. These shares might be taken back at par or at a certain additional amount (at premium). Though they are termed as shares but they are in essence a liability and thus not part of equity. Any dividend paid on such shares is also not considered distribution of profits and thus treated as an expense in profit and loss. Preference shares are one example that may be redeemed.
- Irredeemable shares: Shares that entity has no intention to redeem. For example ordinary shares and irredeemable preference shares. These shares are treated normally as part of equity and any dividend paid is treated as distribution of profits.
Based on participation in profits
- Participating shares: Some preference shares have “extra topping” i.e. they receive certain share of profit in addition to agreed rate of dividend under certain conditions.
- Non-participating shares: Such shares receive only agreed fixed rage of dividend (usually in case of preference shares).
Based on cumulation of profit
- Cumulative shares: Though preference shareholders enjoy preferred service in distribution of profit but if there are no distributable profits then even preference shareholders will not get a penny. However, management may agree to pay the dividends which might have been paid had the profits available in the earlier period then such shares are cumulative preference shares. The concept is shareholders have the guarantee that they will receive the dividend whenever profits are available and it may occur in a period different from actual. For example if the shareholder has not received the dividend of 2013 then he will be paid his share in 2014 if the profits are available. In short unpaid dividends are accumulated and paid as and when profits are available in future period.
- Non-cumulative shares: If there is no agreement as the case above and profits are not available for a certain period then nothing is paid or carried forward to next period. That means if a certain period is skipped there is no compensation for it in the future.
Based on convertibility
- Convertible shares: Sometimes preference shareholders are given the option to convert their preference shares to certain number of ordinary shares. This can happen for many reasons such as voting rights, ownership/control etc. Conversion may be of equal or unequal number of ordinary shares and this option may be available at the time of actual issue but exercisable only after certain time has passed or condition occurred.
- Non-convertible shares: These shares cannot be converted to ordinary shares.
In certain jurisdictions entities are allowed to have several classes of shares with different terms applicable to each class of shares. For example entity may have class-1 and class-2 whereas class-1 shares have voting rights with dividend of 25 cents per share and a nominal value of $1. Class-2 can be without voting rights but with dividend of 50 cents and a nominal value of 10 cents.
Entities can annex certain other types of terms and conditions to specific issue of shares thus creating separate class of shares from the rest.
Some other types include:
Right shares: Once the entity is established and after first issue of shares any subsequent issue of shares is termed as right issue or right shares. Existing shareholders are given option to buy the shares via an application called optional letter. This option letter gives the right to the holder to by shares in the company. This may be held by the existing shareholder or he may choose to sell the option letter to someone else and in that case whoever holds it will have the right to receive shares. Usually these shares are sold lower than market value that can either be at premium or discount.
Bonus shares: These shares are issued to existing shareholders without receiving any consideration. These shares are issued against certain reserve i.e. the purpose of issuing such shares is to capitalize a particular or multiple reserves. Bonus issue does not alter ownership percentage of the shareholders. These shares are always issued at par.
Easy to understand classification
If the above classification is hard to understand then following classification can help understand how sub-classifications are normally seen:
- Ordinary shares
- Preference shares
- Redeemable preference shares
- Irredeemable preference shares
- Cumulative preference shares
- Non-cumulative preference shares
- Participating preference shares
- Non-participating preference shares