F1 1.04 Shares

Company shares

Private companies limited by shares and public limited companies raise money for use in their businesses by issuing shares and receiving payment for these shares from investors. There are two broad classes of shares.

  • Ordinary shares
  • Preference shares

Ordinary shares

Ownership of ordinary shares enables the holder to share in the risks and rewards of a company. This means that if the company does well, the ordinary shareholders will benefit but if performance is poor, the shareholders will suffer.

Ordinary shareholders are the true owners of a company and the portion of company that they own is dependent on the type and number of ordinary shares that they own and total the number of ordinary shares in issue (i.e. the number held by all the ordinary shareholders).

For example: Let’s say that a company has 200 ordinary shares in issue. These are owned as follows:

  • Susan owns 110 shares
  • Michael owns 40 shares
  • Owen owns 50 shares

Susan therefore owns 110 out of 200 shares in the company; i.e. 55%, Michael owns 40% and Owen owns 25%.

This ordinary shares will also give the shareholders rights to vote on resolutions at shareholder meetings in accordance with their shareholdings. If we consider the above example, Susan’s shareholding entitles her to 55% of the voting rights of the company, Michael is entitled to 20% and Owen 25%. Thus, for those resolutions that require more than 50% of the votes in order to be passed (e.g. a vote on the appointment or removal of a company director), Susan will be able to get her way, irrespective of how the other shareholders vote.

A company’s shareholders and shareholdings are listed below.
Thomas owns 103,500 ordinary shares, Derek owns 28,300, Moira owns 28,600, Julius owns 34,000 and Steffi owns 14,200.
a) Calculate to the nearest two decimal places the percentage of ordinary shares owned by Thomas
b) Does Thomas hold enough of the voting rights to remove and appoint directors without the assistance of any other shareholders?
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a) The answer is 49.6% (there are a total of 208,600 ordinary voting shares in issue of which Thomas owns 103,500)

b) The answer is no, Thomas’ wishes could be blocked if all the other shareholders voted against him

Dividends on ordinary shares

Dividends are the way that companies return money to shareholders. They are paid from a company’s past profits (known as its retained earnings). Dividends are paid at a rate per share, so the amount paid to a particular shareholder depends on the type and number of shares held by that shareholder.

For example, a company pays a dividend to its ordinary shareholders of 40p per share. The amount payable to an individual who holds 3,000 ordinary shares would be £1,200 (i.e. 3,000 shares at 40p per share).

A shareholder owns 25,290 ordinary shares in a company. The company declared a dividend of 41.3p per share. How much should the shareholder receive?
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The answer is £10,444.77 (i.e. 25,290 x £0.413)

Classes of ordinary shares

Most companies just have one type of ordinary shares in issue. It is however, possible for a company to create several different types, or “classes”, of ordinary shares. Each different class will have its own name and they can have different rights attached to them. By rights we refer to the rights to receive dividends, the rights to vote at shareholders meetings and their rights to receive any payments from the liquidation of the company. The precise rights of a company’s different classes of ordinary shares will be decided upon before they are created but remember that all ordinary shares must still entitle the holder to share in the risks and rewards of the company.

For example, let’s say that a company has the following classes of ordinary shares; Ordinary A shares, Ordinary B shares and Ordinary non-voting shares. When these classes of shares were created it was decided that Ordinary A shares entitle the holder to twice the voting rights of Ordinary B shares and Ordinary non-voting shares do not entitle the holder to any voting rights.

Is the following statement true or false?
“A company’s Ordinary A shares will always have more rights attached to them as a company’s Ordinary B shares”
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The statement is false. The company’s directors and shareholders will decide the rights attached to each class of shares

The Nominal Price of shares

All company shares in the UK, irrespective of whether they are ordinary shares or preference shares have a nominal price (also often referred to as a nominal value, a par value, or a face value).

A nominal price represents the minimum amount at which that company can issue that class of share to a shareholder. So for example, a company that has a class of shares with a nominal price of £1 each cannot issue those shares at a price of £0.99 per share or less.

[Note that this restriction will not affect the market price of the shares, that is the amount that a shareholder could sell their shares at to another existing shareholder or to a new shareholder.]

The nominal prices are usually included in the full name of a company’s classes of shares; e.g.

  • Ordinary shares of £1 each
  • Ordinary A shares of £25 each
  • Ordinary shares of 1p each
  • Ordinary B shares of 19/26p each

Preference shares

It must first be noted that preference shares are not a type of ordinary share and, generally, do not entitle the holder to vote at meetings of the shareholders.

Dividends on preference shares

Dividends are paid on preference shares at a fixed rate based on a percentage of the share’s nominal price. For example:

  • A company has a number of 8% Preference shares of £1 each in issue. This means that every year, the company should pay dividends on each preference share of £0.08 (i.e. £1 x 8%).

As was the case with ordinary shares, a company can have different classes of preference in issue (e.g. a company has both 15% preference shares of £1 each and 12% preference shares of £1 each in issue).

A company is not legally required to pay dividends on its preference shares and this can be very useful for a company that has few profits to pay the dividends from, or if its cash position will not allow them to be paid. In order to protect the interests of preference shareholders however, companies must pay dividends on preference shares before dividends can be paid to their ordinary shareholders.

An individual owns some 8% preference shares in a company. The nominal price of these shares is £4 each, they were issued to the individual at a price of £5 each and currently have a market value of £6 each.
What dividend should the individual receive from one of these shares each year?
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The answer is £0.32, or 32p. This is calculated my multiplying the nominal price of the share by the rate; i.e. £4 x 8%

An individual owns 3,750 12% Preference shares of 25p each. How much should the individual receive each year from their shareholding?
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The answer is £112.50

A dividend of 3p is payable on each share (i.e. 12% x 25p). So the total to be received is 3p x 3,750 shares

Redemption of preference shares

Preference shares can be classed as either irredeemable or redeemable.

  • Irredeemable means that the preference shares will stay in existence throughout the life of the company
  • Redeemable means that the preference shares will be purchased back from the shareholders by the company at a specified date in the future and for a specified amount (often, but not necessarily, the nominal price of the share).
Debt or equity

Preference shares are in some ways, similar to debt, whilst in other ways they are similar to equity. How then, should they be categorized in a set of financial statements?

The basic rule is as follows; if the preference shares are irredeemable we will treat them as equity and if they are redeemable we will treat them as debt.

A company’s retained earnings at start of a financial year are £284,000. At the end of the year the company calculates its losses for the year to be £241,000.

The company has 250,000 10% preference shares of £1 each. The company’s Managing Director wishes to pay a dividend of £5 per share on the 10,000 ordinary shares currently in issue. He has said that if there are insufficient retained earnings to pay all the dividends, the company should pay the ordinary shareholders rather than the preference shareholders as the company is not legally obliged to pay dividends and can therefore choose which shareholders it will pay.

a) Are there sufficient retained earnings to pay dividends to both types of shareholders?
b) Is the Managing Director’s statement about who should be paid if there are insufficient retained earnings to pay all the shareholders correct?
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a) The answer is no. The company’s retained earnings at the start of the year of £284,000 will be reduced by the losses made by the company of £241,000, leaving £43,000 from which dividends could be paid. The dividends to be paid on the preference shares amount to £25,000 (i.e. 250,000 x 10% x £1) which means that no more than £18,000 of dividends could be paid to the ordinary shareholders. The company would need retained earnings of at least £75,000 to pay the preference share dividends and the proposed ordinary share dividends.

b) Again, the answer is no. The Managing Director’s statement is incorrect as dividends on preference shares must be paid before a company can pay dividends on its ordinary shares.

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