Deferred shares are mostly issued to founders of a company as compensation. And these shares do not possess any rights to a company’s assets unless ordinary and preferred shareholders are paid in case of bankruptcy. The Dividend is paid to deferred shareholders only when distributed to all other classes of shareholders.
Companies can also issue deferred shares to venture capitalists or private investor groups as a part of their long-term investment plans.
Features of Deferred Shares
Deferred shares have certain features that distinguish them from other kinds of shares. These features are:
- Dividend payment is made only after other types of shares have been paid.
- Deferred shares are not tradable unless or until a specific deadline is met.
- A dividend is paid to deferred shareholders after a specific event or a certain date.
- The shareholders of these shares possess fewer rights in comparison to ordinary shareholders.
- Such shares are not given preferential status in the event of insolvency of a company. The holders of deferred shares are paid their dues once all other classes of shares have been paid.
- No voting rights are given to deferred shareholders. Like deferred shareholders cannot vote to elect/dismiss the officers or other directors of a company.
Some restrictions may be faced if an investor wants to purchase deferred shares. E.g.,
- Vesting requirements
- Performance of a company (e.g., Dividend is paid only if a company achieves a specific profitability level.)
- Stock’s price in the market
Why are deferred shares issued?
Companies that want to undergo capital restructuring can issue these shares. Capital restructuring is a process in which companies make certain changes in their debt-to-equity ratio to meet the requirements of changing market conditions. The main purpose behind the capital restructuring is the intention of a company is to improve its profitability and mitigate the risks of bankruptcy. Capital restructuring being a part of long-term strategy helps a business to become more feasible and sustainable.
Another reason why companies issue these shares is that they want to increase employees’ loyalty to the company. When a company issues deferred shares to its employees, they are not allowed to dispose of shares until they leave their jobs.
The value of the deferred share is very low in comparison to ordinary shares.
When a company merges both ordinary and deferred shares to form a single group of shareholders, it will increase the value of deferred shares. This increase in the value of these shares is just because of the merger of two share classes and isn’t based on the performance of an entity.
Example of a Deferred Shares
Permanent Interest Bearing (PIB) shares are an example. PIB shares are issued by building societies, and it also includes an interest rate element. Generally, these shares are irredeemable, or they can be redeemed in some of the cases but only after an extensive time period from the date of its issuance. To compensate the shareholders for an extensive time period restriction, an interest rate is associated with PIBs. However, the fluctuations in the rate of interest over the long term may cause a reduction in the price of these shares.
These shares are issued by the company to founders, venture capitals, and investor groups to strengthen their affiliation with the company. These shares do not carry the same preference of rights as in the case of ordinary shares. For instance, in the case of company liquidation, they are paid in the last if any assets are left after paying to all the debtors and other classes of shareholders. Further, multiple restrictions are attached with these shares, including vesting requirements, company performance, and price.
Also read, the importance of financial analysis