Shares of publicly traded corporations are not all created equal. Some shares, which are also called stocks or equities, give owners greater benefits or voting rights than owners of other classes of stock. The corporation’s owners can create the number and nature of share classes in almost any manner they see fit. Corporate charters – not the law or the courts – define the difference between the classes of stock, often designated as Class A, B and C.
Understanding how various classes of stock differ can help investors make wiser choices when it comes to buying stock.
What Are Share Classes?
Share classes are a way of assigning different rights to different stockholders. They can address issues such as voting authority, dividends and rights to the company’s assets and capital.
For example, a company might issue ordinary stock with one vote per share, designated as Class A shares, then also issue executive stock with 100 votes per share, designated as Class B shares.
A company’s board might set different share classes for many reasons. One of the most common reasons is to keep voting control of the company in a few, well-defined hands by establishing different voting rights for different shareholders. To understand this further, it helps to understand the nature of stocks.
Why Stocks Come in Different Classes
When a company issues shares, it is raising funds by selling partial ownership of itself, either privately to a restricted set of potential owners or on the public market to almost anyone.
Absent other agreements, a company’s shareholders own a percentage of that company’s total assets and profits. They also have voting rights in proportion to the number of shares each individual holds.
As a hypothetical example, Grow Co. chooses to sell 25 percent of its total ownership. It might release 50 shares of stock. In this case, each share of Grow Co. would confer ownership of 0.5 percent of the entire company. (This is a simplified example. In reality companies typically release millions of shares when they issue stock.)
Companies sell shares of stock in order to raise funds from investors, but in doing so they expose their governance and assets to the market. Many, if not most, accept this risk or mitigate it by simply restricting the number of shares they release. Others, however, respond by defining different classes of shares to make sure that voting rights stay in specific hands.
How Share Classes Are Defined
Perhaps the most important thing to understand about share classes is this: Companies set share classification at their own discretion.
When a company issues Class A and Class B shares of stock, it can define these shares almost entirely as it pleases. It can give Class B shares three votes each, or it can say that Class A stock receives half the dividend access of Class B. So long as the definitions do not violate a shareholder’s legal rights, the company can set these terms as it pleases.
Companies define share classes in their corporate charter. They generally do so when they first begin issuing shares of stock, although the company can amend its charter later to change these definitions. It cannot change the definition of shares currently held by existing shareholders, but it can define new shares as it issues them.
There are a few common rights that companies will grant or restrict when they create share classifications. They include:
- Nonvoting Shares – The owner has no right to vote in corporate governance.
- Common/Ordinary Shares – The owner typically has a single vote per share. The shareholder also has access to dividend payments and corporate assets without priority.
- Executive Shares – The owner has priority voting rights, typically multiple votes per share. Companies typically issue these to ensure that the directors and owners retain control of the company even after putting its stock on the public market.
- Preferred Shares – These shares pay a designated amount in dividends at regularly scheduled intervals. The amount paid is often greater than common stock dividends. They may also pay their dividends first, meaning that if there’s a limited amount of money to distribute the preferred shareholders will be guaranteed a payment. Finally, preferred shareholders may have priority when it comes to distributing corporate assets after a windup. Preferred shares often do not confer any voting rights for their holders.
- Deferred Shares – The opposite of preferred shares. The shareholder may receive a smaller amount of dividend payments and is paid last when it comes to dividends and corporate assets. If, for example, the company pays a dividend but doesn’t have enough money to pay all shareholders, deferred shareholders will not receive payment.
The value of different shares varies. Deferred shares, for example, pay fewer dividends and pay them less often. As a result, they’re typically worth less than ordinary stock. Nonvoting shares confer less control over the company, yet for an investor who is interested only in a financial return this may not influence the stock’s value by much.
Defining Shareholder Rights
Corporations typically issues different share classes to accomplish one or both of two things:
- Determine who has voting rights over the company, and ensure that the existing owners can keep control despite putting shares of ownership on the public market;
- Determine who has first call on the company’s profits and assets.
As discussed, a company defines share classifications at its own discretion. This means it can choose how many share classes to create and it can choose how to define each one. Companies that do create share classes will typically create two or three. For example, a common set of stock classes might look like this:
- Class A, Common Stock – Each share confers one vote and ordinary access to dividends and assets.
- Class B, Preferred Stock – Each share confers one vote, but shareholders receive $2 in dividends for every $1 distributed to Class A shareholders. This class of stock has priority distribution for dividends and assets.
- Class C, Executive Stock – Each share confers 100 votes. Shareholders receive ordinary access to dividends and assets.
Here, our company has chosen to create three tiers of stock. Class A stock is intended for average investors, and as a result it is ordinary stock with no special limitations or privileges. Class B stock may have been intended for initial investors back when the company was just starting up. By offering greater financial rewards, the company hoped to secure financing back when it needed that.
Class C stock, in our example, may never have hit the market. The Board of Directors has held onto that, making sure that they retain voting control over this company no matter who buys up the Class A and Class B stock.
This is, of course, just an example. Our company could have chosen to define its shares in any way it chooses. The only limitations are the SEC and finding investors who’ll buy them.
The main decision retail investors will face when considering a stock purchase is between common or outstanding shares, on the one hand, and preferred shares, on the other hand. Investors who need a steady stream of income should consider preferred shares. That’s because the regularity and amount of those dividends are guaranteed while common stock dividends can vary or be terminated at the board’s discretion. On the other hand, investors looking for capital appreciation should carefully consider common or ordinary stock.
- Consider talking to a financial advisor about which class of stock best fits your investment goals and timeline. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Don’t forget that each corporation defines its own classes of shares at their discretion. So be sure to understand what precisely is on offer when it comes to making an investment decision.
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