Types of share capital
/Share capital refers to the funds that a company raises from selling shares to investors. For example, the sale of 1,000 shares at $15 per share raises $15,000 of share capital. There are two general types of share capital, which are common stock and preferred stock. The characteristics of common stock are defined by the state within which a company incorporates. These characteristics are relatively standardized, and include the right to vote on certain corporate decisions, such as the election of a board of directors and the adoption of poison pill provisions to fend off potential acquirers. In the event of a corporate liquidation, the common stockholders are paid their share of any remaining assets after all creditor claims have been fulfilled. If a company declares bankruptcy, this usually means that the holdings of all investors are either severely reduced or completely eliminated.
Preferred stock is shares in the equity of a company, and which entitle the holder to a fixed dividend amount by the issuing company. This dividend must be paid before the company can issue any dividends to its common stockholders. Also, if the company is dissolved, the owners of preference shares are paid back before the holders of common stock. However, the holders of preference shares do not usually have any voting control over the affairs of the company, as do the holders of common stock.
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Types of Preferred Stock
There are many types of preferred stock. The features of one preferred stock offering can vary from another simply because the investors willing to buy these shares demand certain features. Consequently, you may see combinations of any of the following types of preferred stock:
Callable stock. The issuing company has the right to buy back callable stock at a certain price on a certain date. Since the call option tends to cap the maximum price to which a preferred share can appreciate (before the company buys it back), it tends to restrict stock price appreciation. Conversely, it gives a company's management additional flexibility to alter the capital structure of the business.
Convertible stock. The owner of convertible stock has the option, but not the obligation, to convert the shares to a company's common stock at some conversion ratio. This is a valuable feature when the market price of the common stock increases substantially, since the owners of preferred shares can realize substantial gains by converting their shares.
Cumulative stock. Under a cumulative stock arrangement, if a company does not have the financial resources to pay a dividend to the owners of its preferred shares, then it still has the payment liability, and cannot pay dividends to its common shareholders for as long as that liability remains unpaid.
Non-cumulative stock. Under a non-cumulative stock arrangement, if a company does not pay a scheduled dividend, it does not have the obligation to pay the dividend at a later date. This clause is rarely used, given the obvious negative impact on investors.
Participating stock. Under a participating stock arrangement, the issuing company must pay an increased dividend to the owners of preferred shares if there is a participation clause in the share agreement. This clause states that a certain portion of earnings (or of the dividends issued to the owners of common stock) will be distributed to the owners of preferred shares in the form of dividends.
Types of Common Stock
There are fewer types of common stock than preferred stock, since most organizations only issue a single generic type of common stock. Nonetheless, it is possible that some combination of the following share types may be present within a corporation:
Class A common stock. Class A common stock usually comes with full voting rights, often giving shareholders one vote per share on important company matters. This type of stock is typically held by founders, executives, or early investors to maintain control over company decisions. Class A shareholders also benefit from dividends and capital appreciation if the company performs well.
Class B common stock. Class B common stock often has fewer voting rights than Class A stock or may carry no voting rights at all. It is usually issued to the general public during initial public offerings (IPOs) or through secondary markets. Although voting power is limited, Class B stockholders still receive dividends and can benefit from the company's long-term growth.
Class C common stock. Class C common stock usually carries no voting rights, making it primarily attractive to investors focused solely on financial returns rather than corporate governance. Companies often issue Class C shares to raise capital without diluting the control of Class A or Class B shareholders. Class C stockholders still receive dividends and share in the company’s capital gains.
Restricted stock. Restricted stock is typically granted to employees, executives, or insiders as part of compensation packages but comes with limitations on when it can be sold or transferred. These shares usually vest over time or after meeting specific performance goals. Once restrictions lapse, the shares become regular common stock, giving holders full rights to dividends and capital gains.
Voting and non-voting common stock. Some companies issue both voting and non-voting common stock, clearly distinguishing between shareholders who can participate in governance and those who cannot. Non-voting stock is often given to general investors, while voting stock is reserved for insiders or key investors. Both types still share equally in dividends and capital appreciation, despite the difference in control rights.
Terms Similar to Share Capital
Share capital is also known as equity capital.