Hamilton, pp. 383-391: Types of Equity Securities


Here comes nomenclature!


1.     Shares Generally


Let’s look at equity capital under the Model Business Corporation Act.  You divide up the ownership interest in a corporation into shares.  You can have different classes of shares.  Each class must have something that makes it different from the other classes, and all the shares within one class must have the same rights.  If there is only one class of shares issued, they may be called “common shares”, “capital shares”, or just “shares” or “stock”.


When you own a share of stock, you can vote for the directors of the corporation and you are entitled to a share of the corporation’s net assets when dividends or other distributions are paid out.  Not every class of shares needs to have these powers, but at least one class must have both.


2.     Common and Preferred Shares


Common shares have the two rights described above.  Preferred shares have some rights that are preferential to common shares, but they are also limited.  The preferred shares may have the right to a certain amount of money before the common shares get any money, but at the same time these shares are non-voting.  If the company screws up in certain ways, though, the preferred shares can get voting power.  Preferred shares basically are higher in the pecking order in terms of who gets dividends or distributions first.  Dividends are paid out of earnings to shareholders.  Distributions, on the other hand, are paid out of capital.  There are special rules for distributions, but not necessarily for dividends.  Shareholders have other, non-financial rights too.


3.     Special Rights of Publicly Traded Preferred Shares


These shares get cumulative dividend rights, which basically means that if you don’t pay out dividends to preferred shareholders for a few years, you have to sort of make back payments of dividends to them before you can make any dividend payments to the common shareholders.  These shares usually don’t have voting rights except under certain special circumstances like when preferred dividends haven’t been paid for a certain amount of time.  If the corporation dissolves, the preferred shareholders will have a shot at the proceeds from selling the company’s assets before the common shareholders get it.


Preferred shares can be made redeemable by the corporation, meaning the corporation can buy back the shares at a fixed price and the shareholder must accept.  The redemption price is typically made higher than the specified amount of money the preferred shareholder is entitled to if the corporation dissolves.  Preferred shares can sometimes be made convertible into regular old common shares at the option of the shareholder.  The conversion ratio is set such that it’s not worthwhile to convert the preferred shares unless the common shares appreciate in value quite a lot.


4.     Classes of Common Shares


There can also be different classes of common shares!  There can be non-voting shares, for example.  There can be classes that get more dividends.

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