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.