Discuss types of shares that are mostly used to finance companies;
Introduction
To finance a business from its own stock may take different forms. The following are the
common types of shares that are mostly used to finance companies;
Ordinary (equity) Shares
These are shares that are issued to the real owners of the company. They are typical sold in their
nominal value. The nominal value of the shares have no connection with the market prices of the
shares in the capital markets except when they are traded for cash then their issue prices more or
equal to their nominal value. These shares can also be issue as deferred shares which mean that
they can only receive dividends after a certain date or when profit levels have reached a certain
target. Their voting rights may also be restricted but their major importance is that the shares
represent ownership rights to the company.
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Ordinary shareholders can finance their companies by paying for additional new shares or
through recycling retained profits in the business instead of issuing profits as dividends. This
method provides simple and low cost source of funding. When shares are issued to existing
shareholder or through the use of retained earnings then the company retains the control and
ownership of the company (Williams, Haka, Bettner. & Carcello, 2008).
Preference Shares
Preference shares can also be issued to raise funds for a company. These shares carry dividend
that have fixed percentage. Unpaid cumulative preference shares are carried forward to later
periods but the dividends accruing to ordinary shareholders cannot be paid until preference share
holders have been paid. The major advantage of cumulative preference shares is that the
payments of dividends can be carried forward when the sales are poor unlike the interest on
debentures or loans that must be paid as scheduled. Preference shares have no voting rights
hence they cannot dilute the control of the company by the existing shareholders. Preference
shares lower a company’s gearing ratio unless the shares are redeemable. Non-payment of
dividend to preference shareholders does not result in acquisition of a right to appoint a receiver
as in the case of debentures. The major disadvantage is that where as interest on loans and
debentures are tax deductible the dividends on preference shares are not. But investors prefer
ordinary shares as they are secured and their dividends are not as attractive as the ordinary shares
However, the stock option is only available to public companies that can be allowed to issue
their shares to the public. The major disadvantage of public companies is that there is loss of
control and ownership of the company as all the shareholders have equal voting rights. Sole-
traders on the other hand have full control of their companies but opportunity of growth is
limited due to lack of adequate capital and restriction on sale of shares to the public. Partnerships
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are also another form of business organization. The number of partners is also limited from 2 to
50 but in some states the number has been increased slightly hence the restriction on the number
of members is also a disadvantage for partnerships that need more members.
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References
Williams, J. R., Haka, S.F., Bettner, M.S. & Carcello, J.V. (2008) Financial & Managerial
Accounting, McGraw-Hill Irwin, p. 40.
