What is an Ordinary Share? Differences from Preference Shares

Companies need capital for their operations and one of the common ways of raising it is by listing themselves on stock exchanges. Stock market listing gives companies access to unlimited capital without the obligation of debts.

Companies also have the liberty to issue different kinds of shares depending on their requirements. Ordinary shares are the most popular types issued by a majority of companies. In today’s article, we will discuss the nature and benefits of ordinary shares.

What are ordinary shares?

Ordinary shares are synonymous with equity shares and common stocks. 

Companies issue these shares to shareholders to raise capital from them in exchange for part ownership of the company. The number of units held represents the shareholder’s portion of ownership in the company.

Since ordinary or equity shareholders are part owners of the company, they also get voting rights, through which they can actively participate in the company’s management. Besides, equity shareholders are also paid dividends from the company’s profits. 

Features and types of ordinary shares

The two features of ordinary shares that differentiate it from other shares are:

• Voting rights – Every ordinary shareholder is eligible to vote during the company’s annual general meeting. Each unit of a share represents one vote.
• Dividends – Ordinary shareholders are eligible to receive dividends per each ordinary share held, which gives them an additional income benefit besides capital appreciation of shares. However, they receive dividends only when the company makes a profit and meets all other financial commitments. 

Some corporate actions result in issuing different types of shares to shareholders, which still come under the category of ordinary shares.

• Bonus shares: This is where companies issue bonus shares to existing shareholders at no additional cost. The main objective of such shares is to reduce the market price, increase liquidity to improve participation from the public and reward existing shareholders.
• Right shares: Right shares are also issued to existing shareholders at a discounted price, as compared to the prevailing market rate. The objective here is to raise additional capital without going through additional formalities or bringing in new shareholders. 
• Sweat shares: These are usually issued to employees as part of the company’s ESOP (Employee stock option plan) to recognise and award employees for their efforts.
• Shares with limited or no voting rights – Though voting is a fundamental feature of ordinary shares, companies sometimes limit voting or issue some equity shares with ownership but no voting rights.

Benefits of ordinary shares

From the investor’s perspective, ordinary shares allow them to become part owners of large public limited companies. Holding these shares also allows them to participate in the company’s management, giving them all-round exposure.

Ordinary shares provide an additional income source to investors by paying dividends. Besides, equity shares give the benefit of capital appreciation when share prices increase, allowing investors to grow their wealth.

From the company’s perspective, equity shares allow companies to raise as much capital as they need from the public. It helps when companies do not want to rely on debts to arrange the required capital. Besides, equity shares also give companies the advantage of stock market listing, which significantly contributes to the company’s brand image and goodwill. 

Limitations of ordinary shares

Dividends to equity shareholders are one of the last priorities for companies. Dividends cannot be considered a regular source of income, as they are paid only when the company profits. The rate of dividend also varies based on the amount of profit. Besides, equity dividends are paid after paying interest to debenture holders and dividends to preference shareholders. Equity shareholders also have the last priority while the company liquidates.

Another disadvantage to ordinary shareholders is the risk of losing money. Equity share prices are subject to constant fluctuations in the market. A decrease in its price can lead to losses and severe wealth depreciation.

From the company’s perspective, equity shareholders have ownership of the company, which dilutes the power of the management. The company cannot enjoy profits as it will have to share it with all the shareholders. Having multiple owners also increases the possibility of conflicts and disputes. Besides, listing on the stock market will lead to companies being in the public eye at all times. Companies are constantly scrutinised, and every small mistake affects the share price and goodwill. 

The differences between ordinary shares and preference shares

Preference shares, as the name suggests, give preferential rights to holders of these shares.

Preference shareholders are prioritised in dividend payments and during the company’s liquidation. They come before equity shareholders but after debenture holders. They also receive a fixed rate of dividend, contrary to equity shareholders, whose dividend rates vary as per the company’s profits.

However, unlike ordinary shares, preference shareholders do not get voting rights, though they own a part of the company. 

Bottomline

Ordinary shares or equity shares are the most common kind of shares companies issue. These shares allow companies to raise capital from the public by giving up a portion of the ownership.

Equity shares are popular among investors since they give voting rights, dividends and capital appreciation. However, such shares carry a lot of uncertainties, making them one of the high-risk investment tools. 

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