Legal AdvicePrivate Limited

Types of Shares for Private Limited Companies

When you own a share of a private limited company, you own a piece of its ownership. In this article, we will explore the numerous rights that accompany the different types of shares.

There are a number of investment options available to those looking to incorporate a company in India. Most people probably only think of common shares when they think of ownership in a private limited company, but in reality, there are numerous types of ownership opportunities available to Indian citizens.

But first, here’s a birds view of the kinds of shares in a Private limited company:

Major Types of Shares in a Private Limited Company 

  • Equity shares

The most common and extensively used type of share in a private limited is equity shares. As per the Companies Act of 2013, equity shares are any shares other than preference shares.

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All equity is treated equally. So if you own equity in a company, your shares come with all the voting and other rights inherent in them. Furthermore, equity shares do not have any preferential privileges in terms of capital repayment or dividend payment. In fact, equity shares are much riskier than preference shares.

  • Equity shares with differential voting rights

This category of equity shares is usually issued to founders or CEOs of a private limited company so that they can have greater control over the day-to-day affairs of the company. Additionally, such shares give higher voting rights to certain classes of investors.

Google and Facebook are two well-known companies that have issued such shares. However, in India, to issue such shares, you must show that you are capable of distributing profits in terms of dividends for at least three years in a row.

  • Preference shares:

These shares are, as stated, preferential in nature. The advantage of holding a preferential share is that, in case of Liquidation of the company preferential shareholders will be repaid first, once all other debts of the company are settled. 

Only after preferential shareholders are repaid will the common stockholders (equity owners) be paid out. Moreover, preference shares yield a fixed or absolute rate of dividend whereas a common share does not possess such guarantee or preferential rights. In fact, such shares are less risky when compared to equity shares. However, they don’t have any voting rights.

Types of Preference Shares

  1. Cumulative and Non-cumulative:

A non-cumulative preference share is a right to a yearly dividend determined by a proportion of profit. If due to a lack of profit, no dividend is declared in any year, the holders of the preferred shares shall not be allowed to demand the unpaid dividend in the following year or years in regard to that year. 

Cumulative preference shares, on the other hand, continue to give priority shareholders the opportunity to collect unpaid dividends in any future year or years where profits are available for distribution. In this instance, when profits become available, uncompensated dividends are accrued and paid out.

2. Redeemable and Non-redeemable:

Redeemable preference shares are also known as callable preferred stock. These shares must be reimbursed by the company after a fixed duration. Redemption is to be done after the term for which the preference shares were issued has come to an end.   

Irredeemable preferences, on the other hand, signify that the company does not have to pay back preference shares except when the company is shutting its doors or winding up. The Companies Act of 2013:, however, prevents a company from issuing irredeemable preference shares.

As a general rule, a company limited by shares may issue preference shares liable to be redeemed within a period not exceeding twenty years from the date of their issue.

3. Participating and Non-participating 

A participating preference share receives a fixed rate of dividend and also a share in the company’s extra earnings. Most investors buy participating preference shares in those companies which are more likely to generate robust profits.

A non-participating share on the other hand has no right over the extra earnings of a company. This category of shareholders receives only dividends at pre-fixed rates.

What is the Significance of ESOPs

A common problem that most entrepreneurs face is how to motivate their employees in a mutually beneficial way. Employee Stock Option Plans (ESOPs), which are employed by both small and large enterprises, are the most practical solution to this dilemma. It keeps deserving personnel motivated to help the company flourish. It also assures that you don’t lose them for a number of years.

Moreover, companies provide stock ownership to their employees in an ESOP at no upfront cost in lieu of the work they accomplish. Shares, though allocated to employees, are granted only after a predefined period.

 It should also be noted that such an ownership stake in a company cannot be given to personnel such as freelancers, promoters, consultants, etc.

The Takeaway

Determining the structure of ownership most suitable for a business requires expert advice and professional knowledge. Get in touch with our experts right away for everything you need to structure your private limited company’s capital model in the most efficient manner possible.

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