Different Types Of Preferred Shares
Setting up a new corporation in Alberta can be a confusing process. One of the first documents you must prepare is the Articles of Incorporation (the “Articles”) which, among other things, spells out how many and which types of shares are to be issued. Learn more about articles here. Issuing multiple classes of shares is useful to attract investors and allow the company to access more capital. Investors looking to purchase shares in a company may choose between two types of shares, namely: common shares and preferred shares. This article explains the four chief types of preferred shares used by corporations in Alberta. If any questions remain, the corporate lawyers at Kahane Law Office, located in Calgary, assist companies looking to establish proper share structures.
What Is A Share And A Share Class?
Shares represent an interest of ownership in a corporation. The more shares you own compared to other shareholders, the greater percentage of the company you have. One share equals one unit of ownership which entitles the owner to select rights and privileges.
A share class is a type of security. No legal limits exist on the number of share classes a company determines it wants to set out in its Articles. Including various share classes allows a company to have shareholders with different rights. For instance, the founders of a business may wish to hold shares that allow for voting to retain control of the corporation and may issue non-voting shares to investors who are not allowed to vote on how the corporation is governed but can still participate in the corporation’s economic success.
In Alberta, your corporation must have at least one class of shares. For many small businesses, having one type of common voting share is sufficient. If the corporation only issues one type of share, then such shares must provide the right:
- To vote;
- To receive dividends (distributions of the corporation’s profits) if the corporation’s board of directors has declared any; and
- To obtain any remaining property after the paying off of creditors if the corporation dissolves.
If your corporation has multiple share classes, each of the above-mentioned rights must be assigned to at least one class of shares. However, each right can be provided to more than one share class.
Generally, corporations set up preferred shares to entice investors to inject capital into the corporation or to raise money. In exchange, investors may receive preferred shares which offer preferential rights in contrast to common equity holders. Such advantages may include the right to collect fixed dividends and the ability to be first in line to receive liquidation proceeds (after creditors) in the event that the corporation dissolves. However, unlike common shareholders, preferred shareholders usually have no right to vote in corporate governance.
Furthermore, preferred shareholders may have a preferential claim to dividends than common shareholders and the dividends may be cumulative. In that instance, if a share dividend payment is missed, the missed dividends are accumulated and the corporation must pay its preferred share shareholders in full prior to paying any common dividends. Conversely, if the dividends are not cumulative, the corporation may skip paying the dividend completely without penalty. However, it may make it challenging for the corporation to raise capital in the future.
Types of Preferred Shares
Preferred shares can be structured in various ways to offer different benefits tailored to market conditions. Four common types of preferred shares are:
- Floating rate;
- Convertible; and lastly
Floating Rate Preferred Shares
Floating rate preferred shares, also known as “variable rate” preferred shares, are a type of share that offer fixed dividends quarterly or monthly and floating rate dividends thereafter that fluctuate. Typically, floating rate preferred shares set out a minimum dividend and is repayable in cash at maturity.
Such shares may also be retractable, meaning that the share issuer can recall the issue at any time prior to maturity in exchange for equal value of common shares or cash. Your corporate intentions set out which share makes most sense to use. If unsure, our team sits down with you and evaluates the best type for your specific situation.
Perpetual Preferred Shares
In general, perpetual preferred shares do not have a maturity date and shareholders are paid a fixed dividend typically every quarter. Perpetual preferred shareholders do not have voting rights. If a perpetual preferred share is retractable, the issuer can call back the share and provide the shareholder with an equal value of cash or common shares.
Convertible Preferred Shares
Shareholders that hold convertible preferred shares receive the option to convert their shares to a different class of share at a fixed price on a specified date during a certain period. This provides shareholders the flexibility to convert preferred shares into common shares.
Rate-Reset Preferred Shares
Lastly, rate-reset preferred shares provide shareholders with a fixed dividend payment. However, that rate of payment generally resets every five years. Normally, once the five-year fixed rate period passes, the shareholder has the option to hold the fixed rate preferred shares for the next five years or convert the shares to a floating rate security.
Assistance With Structuring Corporate Shares
Throughout the life of a corporation, ascertaining which classes of shares to issue and what rights to attribute to each type of share should be an ongoing consideration. Regardless of the stage of your business life cycle, our experienced corporate lawyers optimize your share structure. We also assist draft the Articles to meet your business’ fundraising, operational and tax-planning needs. We often find that the easiest way to provide people with initial information or to set up an appointment is by email. Email us directly here. We also love to hear from clients, call us directly at 403-225-8810 locally in Calgary, Alberta toll-free at 1-877-225-8817.