Shares Under Companies Act: Meaning, Types of Shares & Preference Shares Explained

What Are Shares?

A share is a unit of ownership that represents an equal proportion of a company’s capital. It gives the holder, known as a shareholder, a proportionate claim on the company’s profits and a corresponding obligation in respect of its debts and losses.

A share signifies the interest of a shareholder in a definite portion of the company’s capital and establishes a proprietary relationship between the company and the shareholder. Although a shareholder is the proportionate owner of the company, he does not own the company’s assets, as these belong to the company itself, which is a separate legal entity.

A share is treated as movable property and is considered a personal estate. It can be transferred in the manner prescribed by the company’s Articles of Association and may also be mortgaged or pledged. Further, under the provisions of the Sale of Goods Act, 1930, shares are included within the definition of “goods.”

Every share issued by a company is evidenced by a share certificate under the company’s common seal, specifying the shares held by the member. The share certificate serves as prima facie evidence of the member’s title to such shares. However, a share certificate is not considered a negotiable instrument.

Types of Shares

According to Section 86 of the Companies Act, a company can issue mainly two types of shares:

1. Preference Shares

Preference shares, also known as preferred stock, are those shares that give shareholders a preferential right over equity shareholders. They usually entitle the holder to receive a fixed rate of dividend and also provide priority in repayment of capital in the event of winding up. Generally, preference shareholders have limited or no voting rights.

A preference share must satisfy the following two conditions:

• It must carry a preferential right regarding payment of dividend at a fixed rate. 
• In the event of winding up, it must carry a preferential right to repayment of paid-up capital. 

Features of Preference Shares

• Claim on income and assets: Preference shareholders have priority over equity shareholders in receiving dividends and repayment of capital. 
• Fixed dividend: Dividend is paid at a predetermined rate. 
• Cumulative dividends: Unpaid dividends may accumulate and be paid in future years. 
• Redemption: Preference shares may be redeemed by the company through methods such as a sinking fund or call option. 
• Participation feature: Some preference shareholders may receive an additional share in surplus profits. 
• Convertibility: Certain preference shares may be converted into equity shares. 

Apart from these main rights, preference shares may also carry:

• A preferential right to arrears of dividend. 
• A right to participate in surplus profits through additional dividends. 
• A right to receive a fixed premium as specified in the memorandum. 
• A right to share in surplus assets during winding up after repayment of capital. 

Advantages of Preference Shares

• Riskless leverage: Enables raising capital without diluting control. 
• Dividend postponement: Payment of dividends may be postponed under certain conditions. 
• Fixed dividend: Investors receive stable returns. 
• Limited voting rights: Management control remains largely with equity shareholders. 

Limitations of Preference Shares

• Dividends are not tax-deductible. 
• Commitment to dividend payment: The company may face pressure to pay dividends regularly. 

2. Equity Shares

Equity shares, also known as common stock, are shares that entitle shareholders to share in the profits of the company as and when they arise. Equity shareholders also have voting rights in the company’s Annual General Meeting and other official meetings.

All shares that are not preference shares are treated as equity shares. Equity shareholders are considered the real owners of the company and enjoy residual rights. They may receive higher dividends when the company performs well, but may also receive nothing if the company incurs losses.

In the event of winding up, equity shareholders are entitled to the surplus assets remaining after payment of all liabilities and repayment of preference share capital, unless preference shareholders are given the right to participate in surplus assets by the Articles of Association.

Features of Equity Shares (Ordinary Shares)

• Claim on income: Residual claim on profits after all obligations are met. 
• Claim on assets: Residual claim on assets after liabilities are settled. 
• Right to control: Equity shareholders participate in management decisions. 
• Voting rights: They can vote in general meetings. 
• Pre-emptive rights: Existing shareholders get the first opportunity to buy newly issued shares. 
• Limited liability: Liability is limited to the amount unpaid on shares held. 

Cumulative and Non-Cumulative Preference Shares

With regard to the payment of dividends, preference shares may be classified as cumulative or non-cumulative.

1. Cumulative Preference Shares: In the case of cumulative preference shares, if the company does not earn sufficient profits in any year to pay the fixed dividend, the unpaid dividend accumulates as arrears. These arrears must be paid out of the profits of subsequent years before any dividend can be distributed to shareholders of any other class. Thus, the right to dividend continues until the accumulated amount is fully paid.
2. Non-Cumulative Preference Shares: In the case of non-cumulative preference shares, dividend is payable only out of the net profits of the particular year. If the company does not earn profits in any year, the shareholder cannot claim the unpaid dividend in future years. The right to receive dividend for that year simply lapses.

Generally, preference shares are presumed to be cumulative unless they are expressly stated to be non-cumulative. Any ambiguous wording in the Articles of Association is not sufficient to treat them as non-cumulative.

Participating and Non-Participating Preference Shares

1. Participating Preference Shares: Participating preference shares are those shares that, in addition to receiving a fixed rate of preference dividend, are also entitled to participate in the remaining profits of the company along with equity shareholders after the equity shareholders have received their fixed dividend. These shares may also carry the right to participate in the surplus assets of the company in the event of winding up. However, such rights must be expressly provided in the company’s Memorandum of Association, Articles of Association, or the terms of issue.
2. Non-Participating Preference Shares: non-participating preference shares are entitled only to a fixed rate of dividend and do not share in the surplus profits of the company. Generally, preference shares are presumed to be non-participating unless otherwise expressly stated in the Memorandum of Association, Articles of Association, or terms of issue.

It is important to note that even if the Articles of Association grant preference shareholders the right to participate in surplus profits along with equity shareholders, this does not automatically give them the right to participate in surplus assets during winding up. Such a right must be specifically mentioned.

Redeemable Preference Shares

According to Section 80 of the Companies Act, a company limited by shares may issue redeemable preference shares if it is authorized by its Articles of Association. These shares may be redeemed either after a fixed period or earlier at the option of the company.

Unlike irredeemable preference shares, where the capital is returned only on the winding up of the company, redeemable preference shares can be repaid by the company during its existence, subject to certain conditions.

Redeemable preference shares can be redeemed only under the following conditions:

• Fully paid-up shares: The shares must be fully paid before redemption. 
• Source of redemption: Redemption must be made either out of distributable profits or out of the proceeds of a fresh issue of shares made specifically for the purpose of redemption. 
• Premium on redemption: Any premium payable on redemption must be paid either out of the company’s profits or from the share premium account. 
• Capital Redemption Reserve Account: Where shares are redeemed out of profits, an amount equal to the nominal value of the shares redeemed must be transferred to the Capital Redemption Reserve Account. 

The amount transferred to the Capital Redemption Reserve Account is treated as part of the company’s capital. Therefore, the provisions relating to reduction of share capital apply to it. This amount cannot be distributed to shareholders as dividend, but it may be used for issuing fully paid bonus shares to shareholders.

Redemption of preference shares is not regarded as a reduction of the company’s authorized share capital. Further, shares already issued cannot be converted into redeemable preference shares.

If a company fails to comply with these provisions, both the company and every officer in default may be punished with a fine extending up to ₹1,000.

The redemption of redeemable preference shares must be notified to the Registrar within one month of redemption. In addition, where such shares have been issued, the company’s balance sheet must clearly state:

• the portion of share capital consisting of redeemable preference shares; and 
• the earliest date on which the company has the power to redeem those shares.