Deferred Shares: Definition, Characteristics, and Comparison
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Summary:
Deferred shares are a form of company ownership that come with unique rights and restrictions. They are typically issued to company insiders, founders, executives, or private investors. Deferred shares have a specific place in the hierarchy of ownership, particularly in bankruptcy proceedings, where they are the last to receive payouts after all other classes of shareholders. This article delves into the intricacies of deferred shares, including their structure, compensation, comparison with other types of shares, and their position in company liquidation scenarios.
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Understanding deferred shares
Deferred shares typically come with several defining characteristics:
Last in line: In bankruptcy or liquidation scenarios, deferred shares are the last to receive payouts, following preferred and common shareholders. This means that holders of deferred shares have the lowest priority in claiming company assets.
Restricted dividend receipt: Deferred shares may restrict the receipt of dividends until dividends have been distributed to all other classes of shareholders. This provision ensures that other shareholders receive their dividends before holders of deferred shares.
Long-term investment: Deferred shares are often issued as part of long-term investment agreements, particularly in the context of venture capital funding. Investors may receive deferred shares as a means of committing to the company’s long-term growth and success.
Uses of deferred shares
Deferred shares serve various purposes within a company:
Executive compensation: Companies often use deferred shares as a component of executive compensation packages. By offering deferred shares to executives, companies incentivize long-term commitment and alignment of interests between executives and shareholders.
Founder incentives: Deferred shares can also be allocated to company founders, providing them with a stake in the company’s success while ensuring that they share in the risks and rewards alongside other shareholders.
Investor alignment: In some cases, companies issue deferred shares to private investors, such as venture capital firms, to align their interests with the company’s long-term goals. By offering deferred shares, companies can attract investment capital while signaling a commitment to sustainable growth.
Deferred shares vs. other share types
While deferred shares and restricted shares share similarities, they also have distinct differences:
Vesting periods: Both deferred and restricted shares may be subject to vesting periods, during which the recipient must meet certain conditions to gain full ownership of the shares. However, the timing and conditions for conversion vary between the two types.
Conversion process: Restricted shares typically convert to unrestricted shares once the vesting period ends, allowing the recipient to exercise full ownership rights immediately. In contrast, deferred shares may have a specified conversion date beyond the vesting period, delaying the recipient’s ability to access the shares.
Deferred shares vs. common and preferred shares
Deferred shares differ significantly from common and preferred shares in terms of their rights and priorities:
Priority in payouts: During bankruptcy proceedings or company liquidation, preferred shareholders have priority over common shareholders, and deferred shareholders rank below both preferred and common shareholders in the hierarchy of payouts.
Dividend restrictions: Unlike common and preferred shareholders, holders of deferred shares may have restrictions on dividend receipt, requiring dividends to be distributed to other classes of shareholders first.
Frequently asked questions
What is the purpose of issuing deferred shares?
Deferred shares serve various purposes, including incentivizing long-term commitment from executives and founders, aligning stakeholders’ interests with the company’s long-term success, and attracting investment capital from private investors.
How do deferred shares differ from restricted shares?
While both deferred shares and restricted shares may be subject to vesting periods, deferred shares typically have a specified conversion date beyond the vesting period, delaying the recipient’s ability to access the shares. In contrast, restricted shares convert to unrestricted shares once the vesting period ends.
What rights do holders of deferred shares have during bankruptcy proceedings?
During bankruptcy proceedings or company liquidation, holders of deferred shares are typically the last to receive payouts, following preferred and common shareholders. They have the lowest priority in claiming company assets.
Are there any tax implications associated with deferred shares?
Yes, holders of deferred shares may face tax implications, particularly regarding the timing of income recognition. Depending on the jurisdiction and specific circumstances, the receipt of deferred share payouts may be subject to taxation as ordinary income or capital gains. It’s advisable for recipients of deferred shares to consult with tax professionals to understand their tax obligations.
Can deferred shares be converted into other types of shares?
Yes, in some cases, deferred shares may be convertible into other classes of shares, such as common or preferred shares. The terms of conversion are typically outlined in the deferred share agreement and may be subject to specific conditions, such as the passage of time or achievement of certain milestones.
What happens to deferred shares if the company is acquired?
In the event of a company acquisition, the treatment of deferred shares depends on the terms of the acquisition agreement and the preferences of the acquiring company. Deferred shares may be converted into shares of the acquiring company, cashed out at a predetermined price, or subject to other arrangements outlined in the acquisition agreement.
Are deferred shares commonly used in public companies?
Deferred shares are less common in public companies compared to private companies. Public companies typically offer more traditional forms of equity compensation, such as stock options and restricted stock units (RSUs). However, deferred shares may still be used in certain circumstances, particularly for executives and key employees who play a significant role in the company’s long-term success.
What factors should be considered before accepting deferred shares as part of compensation?
Before accepting deferred shares as part of compensation, individuals should consider factors such as the company’s financial health and growth prospects, the terms and conditions of the deferred share agreement, the potential tax implications, and the overall alignment of interests between stakeholders. It’s essential to carefully review the terms of the deferred share agreement and seek professional advice if needed before making a decision.
Key takeaways
- Deferred shares are a form of company ownership typically issued to insiders, executives, founders, or private investors.
- They have the lowest priority in claiming company assets during bankruptcy proceedings.
- Deferred shares may come with restrictions on dividend receipt and conversion timelines.
- Pros of deferred shares include long-term commitment, alignment of interests, and attraction of investment capital.
- Cons include low liquidity, dividend restrictions, and the risk of dilution for existing shareholders.
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