Both ordinary shares and preference shares give shareholders ownership in a company, but they can be different from each other in some important ways. We take a look at the main points that differentiate them.
Shares are unit of ownership in a company. When you initially incorporate a new company it’s most common that there is only one class of shares – known as ‘ordinary shares’. These shares all have exactly the same key rights in the company, the most important being:
- Voting rights.
- Dividend rights.
- Right to ownership in the company.
With a single class of ordinary shares these rights are proportionate. For example, if you had ten shares out of 100 you would be entitled to 10% voting rights in, and ownership of the company.
However, under English law share classes are theoretically unlimited, and as companies grow and become more sophisticated they often create more than one class of shares. These additional classes of shares are often referred to as preference shares.
The first thing to bear in mind is that UK company law is extremely flexible. Within the existing legal framework, companies are free to create many different types of shares with often varied rights.
Within early-stage / venture investing, there are common variations that tend to be seen. These variations focus on one of two areas – economics and voting.
There are three main ways in which a company will return value to shareholders:
- Dividends – A payment to shareholders out of the company’s profits.
- Exit – The sale of the business, such as to a corporate purchaser, or the listing of the company’s shares on the stock exchange.
- Liquidation – A high proportion of startups fail and when they do they may often have surplus cash and assets. After the company’s debts are settled there may be some value remaining. This is then returned to shareholders.
- Voting rights
Although directors are appointed by shareholders to run the company on their behalf, it’s ultimately the shareholders, via their votes, who have control of the company.
So, when new share classes are created they can flex any one of these rights, or all of them together. These new classes can rank ahead of the ordinary shares, or behind them, or only have some of these rights versus ordinary shares (e.g. the famous Google non-voting shares.
How preference shares are normally used
‘Preference shares’ usually refers to a share class that ranks ahead of ordinary shares in some way when it comes to economic returns.
Again, this can take many forms, but in today’s market there’s a common form of preference share that’s used for venture investing – the 1x, non-participating, convertible preference share.
The rights for such a share will be as follows:
- The right to a return on an exit or liquidation event of one times the amount paid for those shares (“1x”),
- Before the ordinary shares are paid anything,
- After which the ordinary shares will receive a proportionate amount of the remainder of the proceeds (and the preference shares don’t “participate” in this proportionate return).
So, if you’ve invested for a return, why would you only take back the money you put in (i.e. your 1x)?
This is where conversion comes in. Such preference shares can usually be converted into ordinary shares on notice to the company. If it looks like the company is likely to exit for higher than the valuation than the one on which the investors joined the company, it will often make sense to convert into ordinary shares and participate with the rest of the ordinary shareholders.
Whilst less common these days, we do still sometimes see ‘participating’ preference shares. A participating preference share generally gives the holder the right to their preferential payment (e.g. their 1x) and also the right to participate proportionately alongside the ordinary shares.
There are many other variations on the theme, including:
- Capped participating preferences (e.g. you only receive the preference if your return would otherwise be less than 3x).
- Preference shares that aren’t convertible to ordinary shares.
- Multiple of more than 1x.
- Anti-dilution protection or enhanced or entrenched voting provisions.
What class of share do you receive when investing on Seedrs?
Our view is that Seedrs investors should be receiving the same share class as the other investors that are participating in the same funding round on Seedrs, irrespective of the level of investment. For example, when Revolut raised its latest round on Seedrs, Seedrs investors received the same share class as some of the biggest VCs in Europe, who were investing on the same terms as Seedrs investors.
Because ordinary shares are the default position, if a campaign does not mention share classes then you can assume that you will be investing in ordinary shares, and that unless otherwise disclosed there are no other higher-ranking share classes in the company.
There are occasions where because of tax reliefs (particularly SEIS/EIS) or other advantages which Seedrs investors would find more beneficial, we may agree to take a different class of shares than other investors in the company may hold or be receiving. This will always be sign-posted in a campaign and made clear to our investors.
The Seedrs Advantage Nominee
Through the full-service Seedrs nominee we work as an aggregator for the crowd’s investment. This lets us both look behind the scenes to see what share classes are in place, what their rights are, and work with the company to make sure that regardless of whether you are investing £10 or £1M, you’re treated like any other investor.
We hope this has helped you better understand shares and how they’re structured in early-stage investing a little better. Find out how to invest on Seedrs and why.