The nature and classes of share capital can be better understood once one is aware of what a share is.The shares are a unit which provides ownership interest to an individual in a company. The total share capital of a company is constituted of various smaller units known as shares. The shares when combined together form the capital of the company. Each unit of share is purchased by individuals who in turn become the shareholders of the company. Since they own the capital of the company they are also known as the owners of the company.
The total amount of share that a company is entitled to issue is stated in the Memorandum of Association. It is better known as authorised share capital. But it should be noted that the actual issued capital can be either lower or equal to authorised share capital and can not in any circumstances exceed it.
The Articles of Association of the company states the nature and classes of shares in which the share capital is divided.
The share capital can be bifurcated in the following two classes –
- Preference shares, and
- Equity shares (ordinary shares).
Both the above mentioned classes of share differ in terms of rights available and obligations faced.
1. Preference Shares
As the name suggests, these shares have preference over the equity shares to receive dividend amount (fixed amount or other). These shares can be cumulative or non-cumulative depending on the terms so agreed.
They also enjoy the preferential right to receive capital repayment at the time of winding up before discharging the equity shareholders.
Other than the above conditions, the preference shareholders may also have a right to participate in the surpluses of the company as agreed in the Memorandum or Articles of the company.
Preference shares can further be classified into – cumulative or non-cumulative, participating or nonparticipating and redeemable or irredeemable.
2. Equity Shares (ordinary shares)
An equity share is defined in Section 43 of The Companies Act, 2013 as a share which is not a preference share. This means that unlike preference shares, equity shares are not granted the preferential right in the payment of dividend or repayment of capital in case of winding up.
Since, equity shareholders do not enjoy any of the preferential rights, they bear higher risk of loss of their funds. To compensate this and to attract individuals to invest in equity shares, they are entitled to share the distributable profits (i.e., surplus) of the company post distribution of dividends to preference shareholders. There is no fixed rate at which dividend is distributed as the profits are not certain every year. They also enjoy voting rights as compared to preference shareholders.
Thus, shares are a fraction of the entire share capital and its buyers eventually become the owners of the company. The nature and classes of shares are described in the Memorandum of Association of the company.