Ordinary shares vs preference shares: the difference and which investors want which

How do you know what kind of shares you need when there is no legal definition of an ordinary share or a preference share? The honest answer is that the labels describe what those shares typically do, not what they must do. Here is what ordinary shares and preference shares usually look like, and who tends to hold each.

Keep in mind throughout that you can create any class of shares you wish, within reason. The rights described below are the typical ones, the ones most people mean when they use the words. Your articles of association can attach different rights if the company and its investors agree, so always read the articles rather than relying on the name of the class.

What are ordinary shares?

Ordinary shares are the most common type of share. Typically they carry two rights:

• The right to vote. Ordinary shareholders have a say on the matters that come to the shareholders for decision.
• The right to dividends. A dividend is the right to receive a percentage, or a proportion, of the profits of the company.

Typically, ordinary shares are owned by the founders and co-founders. They are the people running the business, so they want the votes, and they take their return through dividends and through the growth in the value of the company.

What are preference shares?

Preference shares typically are hands-off, but they have the greatest chance of receiving dividends.

They are hands-off because, typically, they do not carry the right to vote. The holder is not involved in deciding how the company is run.

They have the greatest chance of receiving dividends for two main reasons:

• First in line. If there are dividends to be paid, preference shareholders receive theirs before the ordinary shareholders.
• A fixed amount. Preference shares are, in a way, guaranteed a fixed amount of dividend every quarter or every year, rather than whatever the directors decide to declare on the ordinary shares.

So the trade is control for priority. The preference shareholder gives up a say in the business and in return moves to the front of the queue for a predictable return. From the company's side, it can raise money without diluting the founders' voting power, because the new shares do not vote.

Preference shares for angel investors

That trade is why preference shares can be great for angel investors. An angel typically wants to be hands-off. They do not want to be involved in the day-to-day decision making of the company, and they may not want the founders to feel they are. But they do want the greatest chance of receiving a return on the money they have put in.

Preference shares give them exactly that: no vote, a fixed dividend, and priority over the founders when profits are distributed. The founders keep the ordinary shares and keep control.

If you want to go further, there are other types of shares available and other creative rights and restrictions you can use when designing share classes, which I cover in classes of shares explained. Preference shares can also be made redeemable, so the company can buy them back on agreed terms, which I explain in redeemable shares explained.

Next steps

If you are raising money, decide first whether the investor wants a say in running the company or simply a return. Hands-off investors usually point towards preference shares; co-founders usually hold ordinary shares. Then speak to a corporate solicitor about writing the rights of each class into the articles of association, and read how to create different classes of shares for the procedure.