A start-up secures funding by either equity financing or debt financing. In equity financing, there are two different types of shares that a start-up can issue and offer to investors in Malaysia: ordinary shares or preference shares. How does this matter and impact the start-up and investors? 

What are Ordinary Shares? 

Ordinary shares are usually shares issued to the founders of the start up. These shares have more rights and give you control compared to preference shares but are the last to get a claim on assets and income in the event of liquidation. Preference shareholders and other creditors will be prioritized over ordinary shareholders’ claims.

Investors with ordinary shares have voting rights in the company. These shares give you a say in matters such as the selection of the board of directors, changes in the company charter and company direction.

As the owners, ordinary shareholders have a right to the income balance after preference shares dividends are paid. However, dividends for ordinary shareholders can either be paid out or kept as retained earnings. The company may decide for the ordinary shareholders’ dividends to be reinvested for reasons such as to increase the value of the shares of the company or for future expansion.

Ordinary shareholders also have the right to maintain a proportionate share of ownership in the firm. When new shares are issued, ordinary shareholders have the first right of refusal. 

The disadvantages of ordinary shares vs preference shares:

1. Priority of Dividend Distribution: priority is given to preference shareholders. Ordinary shareholders get paid last. 
2. The investment in ordinary shares is volatile compared to preference shares, especially for start-up companies. According to Tracxn, there are approximately 5,000 startups in Malaysia. The failure rate of startups is standing at 90% and only a mere 10% of them will succeed eventually. 
3. In the event that the company is in liquidation, as an ordinary shareholder, your claim on the assets will rank below preference shareholder and other stakeholders, including the creditors etc.

What are Preference Shares? 

Preference shares are shares that take priority over ordinary shares in terms of dividends and asset claims and usually comes with provisional voting rights. Unlike ordinary shareholders, the Provision of Protection only allows voting rights to preference shareholders in the event of no dividend payments. 

The amount of dividend is almost always fixed, either in a fixed sum or percentage of face value.

Shareholder agreements regulate and lay down the terms and conditions of preference shares and the rights annexed to them. 

Characteristics of Preference Shares

Although there may be various classes of preference shares issued by a start up, they have some shared features:

1. Most preference shares produced today can be converted to a number of ordinary shares. 

2. Most preference shares require a cumulative dividend payable to be settled before the ordinary share dividends may be declared. It provides a level of protection for preference shareholders. 

3. Provision of Protection allows voting rights to preference shareholders in the event of no dividend payments. The right to vote is granted after the preference shares dividend is not paid for several times. 

4. Participation is a rare feature which allows preference shareholders to obtain payment of dividends over time depending on income. 

What is the Difference between Ordinary Shares and Preference Shares?

Preference Shares have limited and conditional voting rights but they provide an advantage in terms of dividends, as Preference Shareholders have priority over Ordinary Shareholders when receiving dividends not only when the start up is operational but also in the event of liquidation. 

Preference Shares’ payment of dividends is fixed to the amount specified over an agreed period, which differs from ordinary shares which are subject to income. Dividend payout could be monthly, quarterly or yearly depending on the terms stipulated in the shareholders agreement. In this sense, preference shares are less risky compared to ordinary shares. 

However, this can also be a disadvantage if the start up is gaining high profits since preference shareholders dividends are fixed. 

Ordinary Shares vs Preference Shares: which is better?

There is no single answer to this question. Both shares give different rights and ownership to the holder. If the investor is looking for a less risky investment and stable income, preference shares are the first priority. If the investor is aiming for long-term success and participation in the business with the founders, then ordinary shares should be their first option.