When raising capital by issuing new shares in your company, one of the key decisions you will face is whether to offer ordinary shares or preference shares.
Ordinary shares are the go-to for most investors, as they come with voting rights and the potential for capital growth. Preference shares, on the other hand, can be an attractive alternative. They can be issued with the right to preferential dividends and allow you to avoid diluting the voting power of your existing shareholders, something many companies consider when opting to issue preference shares.
What Are Preference Shares?
Preference shares are a class of shares that comes with certain benefits over ordinary shares. Some key advantages include:
- Priority on Dividends: Preference shareholders may receive their dividends before ordinary shareholders.
- Fixed Dividends: Preference shares often come with fixed dividends, providing investors with a steady and reliable income.
- Priority on Payouts in Liquidation: If the company goes bankrupt, preference shareholders are generally prioritised over ordinary shareholders when it comes to payouts from the company’s assets.
Unlike ordinary shares, preference shares generally do not come with voting rights. This makes them an attractive option for investors seeking income stability but do not want to exercise any influence over corporate decisions in the company.
It is important to note that preference shares can come in various classes, each with its own set of rights and features. It is important to understand that the rights attached to preference shares can differ depending on the company and the specific class of shares issued.
Cumulative or Non-Cumulative Preference Shares
When dealing with preference shares, you should also understand whether they are “cumulative” or “non-cumulative.”
- Cumulative Preference Shares: If the company misses a dividend payment, it must make up for it in the next period before paying any dividends to ordinary shareholders.
- Non-Cumulative Preference Shares: Dividends are not carried forward if missed. Each dividend payment is treated as a separate event, so missed payments are not carried forward.
Understanding this distinction is crucial for investors looking for consistent income from their investments.
Difference Between Ordinary and Preference Shares
Shares in a company confer ownership rights but differ in the entitlements and protections they provide. Ordinary shares and preference shares are the most common categories of equity. Ordinary shares are true equity instruments, providing voting rights and participation in corporate decisions, whereas preference shares have features more akin to debt, typically offering fixed or capped returns and priority on capital repayment, with limited or no voting rights.
Ordinary shares confer on shareholders the ability to participate in corporate decisions and the opportunity to benefit from long-term capital appreciation of the shares of the company. As dividends are not guaranteed and ordinary shares are not redeemable, ordinary shareholders accept greater risk in exchange for the potential of higher returns and a proportionate say in company decisions.
Preference shares, by contrast, are designed with investors’ returns and capital in mind. Unlike ordinary shares, they generally carry no or limited voting rights, giving preference shareholders little influence over corporate decisions. This trade-off is offset by priority entitlement to dividends which may be fixed or subject to a cap, priority payment of capital if the company is liquidated. Preference shares are therefore suited to investors who priorities stable returns over control. Preference shares are regarded as a hybrid between equity and debt-like instruments.
Types of Preference Shares
Redeemable Preference Shares
Some preference shares are redeemable, meaning the company has the option to buy the shares back at a future agreed-upon date and price, or at the discretion of the company’s directors. This feature provides flexibility for companies looking to manage their capital structure over time. Unlike ordinary shares, redeemable preference shares are closer to debt instruments and may be classified in the financial statements as such. This may affect the company’s debt-equity or gearing ratio.
Convertible Preference Shares
Convertible preference shares may offer a fixed dividend for a specified period. At the end of this period, the company can choose to convert these shares into ordinary shares or allow them to remain as preference shares. This structure gives preference shareholders the opportunity to convert their holdings into ordinary shares at a potentially lower price, and may be advantageous if the market value of the ordinary shares has increased and the investor expects the company’s value to grow. Given these characteristics, convertible preference shares are commonly regarded as hybrid instruments, combining features of both debt and equity.
Warrants
Warrants are derivative instruments that give the investor the right, but not the obligation, to buy or sell a security, most commonly equity at a specific price before a pre-determined expiration date. They are often issued alongside bonds or preference shares to make those securities more attractive.
Options
Options are contracts that allow investors to buy (call option) or sell (put option) an asset at a predetermined price within a specific time frame. Unlike preference shares, which provide fixed dividends, options derive their value entirely from the performance of the underlying asset. They are widely used for speculation and hedging risk, giving investors flexibility but also carry the risk of losing their entire investment if the market moves against them. The primary difference between options and warrants is that warrants are typically issues by the company issuing the shares, whereas options are contracts entered into between existing shareholders and potential shareholders.
Overview of Investment Instruments
When raising capital or considering investment instruments, it’s crucial to understand how different securities function. Ordinary shares, preference shares, and their variations typically provide ownership stakes with differing rights and obligations, while derivatives like warrants and options offer more speculative or hedging opportunities.
| Instrument | Nature | Key Features |
|---|---|---|
| Ordinary Shares | Equity | Voting rights, potential for greater capital returns |
| Preference Shares | Treated like debt | Fixed dividends, priority in liquidation, limited or no voting rights |
| Convertible Preference Shares | Hybrid (income + equity option) | Fixed dividends, with the option to convert to equity |
| Redeemable Preference Shares | Hybrid | Either the shareholder or the company can redeem shares for cash |
| Warrants | Derivative | Right to buy shares at a set price in the future |
| Options | Derivative | Right, but not obligation, to buy/sell at strike price |
Table 1: This table outlines the nature and key features of ordinary shares, preference shares (including convertible and redeemable types), warrants, and options.
Overview of Investment Instruments
When raising capital or considering investment instruments, it’s crucial to understand how different securities function. Ordinary shares, preference shares, and their variations typically provide ownership stakes with differing rights and obligations, while derivatives like warrants and options offer more speculative or hedging opportunities.
| Instrument | Nature | Key Features |
|---|---|---|
| Ordinary Shares | Equity | Voting rights, potential for greater capital returns |
| Preference Shares | Treated like debt | Fixed dividends, priority in liquidation, limited or no voting rights |
| Convertible Preference Shares | Hybrid (income + equity option) | Fixed dividends, with the option to convert to equity |
| Redeemable Preference Shares | Hybrid | Either shareholder or company can redeem shares for cash |
| Warrants | Derivative | Right to buy shares at a set price in future |
| Options | Derivative | Right, but not obligation, to buy/sell at strike price |
Table 1: This table outlines the nature and key features of ordinary shares, preference shares (including convertible and redeemable types), warrants, and options.
How to Issue Preference Shares
Securities and Futures Act
In Singapore, an offer of shares is regulated by the Securities and Futures Act 2001 (SFA) if the offer is not made under the exemptions available under the SFA, which are sometimes called “safe harbours”. The Act applies to offers of securities that do not come within the “safe harbours” and to companies listed on regulated markets, and these entities must comply with prospectus requirements and obligations set out in the Act.
However, most small and medium-sized enterprises (SMEs) and startups are not directly governed by the SFA when raising capital. This is because it can be costly and unnecessarily complicated, especially if they are seeking funds from venture capital firms, angel investors, or family and friends. Instead, they fall under general company law, corporate governance requirements, and the applicable exemptions.
Private Placement Exemption
Many SMEs and startups making offers for shares rely on the private placement exemption under the SFA. This exemption allows companies to offer shares to no more than 50 persons within any 12-month period, without having to issue a prospectus. Companies also commonly rely on the small (personal) offers exemption, which permits fundraising up to S$5 million in total, within the same 12-month period.
However, it is important to note that these exemptions come with specific conditions, so seeking legal advice is crucial to ensure compliance with regulatory requirements before making an offer to shares.
Amendment of Company Constitution to Provide for Preference Shares
Before offering preference shares to investors, a company must amend its constitution to comply with Section 75 of the Companies Act. This section requires the company to clearly define the rights of preference shareholders to be set out in the constitution of the company. These include:
- How and when the capital is paid back;
- Participation in surplus assets and profits;
- Whether dividends are cumulative or non-cumulative;
- Voting rights; and
- Priority of payment of capital and dividend in relation to other shares or other classes of preference shares.
This requirement ensures that anyone interested in purchasing the shares (whether third parties or existing shareholders), can easily understand the rights and conditions associated with the preference shares.
How to Amend a Company’s Constitution
To amend a company’s constitution, a special resolution must be passed by the shareholders. This involves:
- At least 14 days’ notice for private companies (or a longer period if specified in the constitution) and 21 days’ notice for public companies; and
- Outlining the proposed amendments in the notice, including those related to the rights and terms of the preference shares; and
- Securing approval of at least 75% of shareholders voting in favour of the amendments.
Once the special resolution is passed, the company secretary must file the necessary documents with the Accounting and Corporate Regulatory Authority (“ACRA”) within 14 days.
Shareholders’ Approval
After the constitution is amended, shareholders must authorise the directors to issue preference shares in accordance with Section 161 of the Companies Act.
This approval must be obtained by way of an ordinary resolution, requiring a simple majority of more than 50% of the votes cast. The resolution typically authorises the director to issue preference shares up to a specified number and within a defined timeframe.
Directors’ Resolution to Issue Preference Shares
Once shareholder authority under Section 161 has been obtained, the Board of Directors may proceed to approve the issuance of preference shares. This includes:
- Determining the number of preference shares to be issued;
- Approving the issue price and key commercial terms; and
- Resolving to allot and issue the preference shares in accordance with the constitution and shareholder mandate.
Issuance of Preference Shares
Once the resolutions are passed, the company can proceed with the issuance of preference shares, and lodge the allotment of shares with ACRA, issue share certificates, and update the company’s register of members.
How a Shareholders’ Agreement and Constitution Work Together
A company’s constitution and shareholders’ agreement both regulate internal operations and shareholder relationships, but they do so in different ways. The constitution is a public document that binds the company and its shareholders, while the shareholders’ agreement is a private contract that allows tailored agreements. They complement each other, yet important nuances exist in their source of authority, enforceability, and level of public scrutiny.
Authority of the Constitution and Shareholders’ Agreement
The constitution derives its authority from Section 22 of the Companies Act. It sets out the company’s governance framework, including matters such as notice periods, quorum requirements, and procedures for convening meetings. It binds the company and its shareholders. Directors and company officers are also required to act in accordance with the constitution when exercising corporate powers, by virtue of their fiduciary and statutory duties.
A shareholders’ agreement, by contrast, is a private contract enforceable under common law. Its legal force comes from the agreement itself, and is intended to regulate the relationship amongst shareholders, although the company can also be added as a party to that agreement. It commonly addresses matters not dealt by the constitution, such as dividend policies, rights of first refusal, dispute resolution mechanisms, and exit strategies.
Privacy of Corporate Governance Instruments
The constitution is a public document filed with ACRA, open to scrutiny and enforceable against all shareholders and the company itself. Enforcement usually requires the company to be a party to proceedings.
The shareholders’ agreement is a private contract enforceable only between the contracting parties. Its confidentiality enables shareholders to address sensitive financial and operational matters such as details about the sale or transfer of shares, exit strategies, rights of first refusal, decision-making processes, treatment of dividends, without the risk of public disclosure, and to tailor provisions to their specific commercial interests.
Hierarchy and Enforcement
In the hierarchy of authority, statute (such as the Companies Act) sits at the top, followed by the company’s constitution, and then the shareholders’ agreement. Statutory law always prevails, meaning the constitution must comply with the Companies Act and other legislation. The constitution sets the minimum governance standards that bind the company and all its members. A shareholders’ agreement may supplement or elaborate on these standards, but it cannot override statutory requirements or reduce the constitution’s minimum provisions, except to the extent permitted by statute.
Conclusion
Raising capital by issuing ordinary or preference shares is a strategic decision that can shape the future of your business. Understanding whether to offer ordinary or preference shares is key to attracting investors and structuring your business effectively.
At Yuen Law, we are committed to guiding you through the entire capital raising process. From advising on regulatory issues and drafting shareholders or investment agreements, to amending your company’s constitution, we handle every aspect of the capital raise to help you structure the best deal for your business.
