By its simplest definition, a shareholder is any person or institution who owns one or more shares of a company's stock. Not all shareholders are equal, however. While some get to vote on key corporate decisions and receive dividends when the company is profitable, others are passive investors who receive a fixed return for their investment every year, such as a guaranteed interest rate on a loan. There are two categories of shareholders who own either common or preferred shares.
What Is a Shareholder?
From partnerships and limited liability companies (LLCs) to corporations, there are various types of business structures. Each has unique characteristics. LLCs, for instance, don’t issue stock and cannot have shareholders. Even though their owners are often referred to as shareholders, they don’t actually own shares of stock. In a partnership, the company's owners are called partners, not shareholders.
Both public and private corporations as well as publicly traded companies, by contrast, may issue stock to investors, also known as stockholders or shareholders. Basically, investors own a piece of the company’s assets and profits. They may sell their shares for profit and earn through dividends.
Common Shareholders and Their Rights
Many companies only have one type of share, known as common stock. As such, most shareholders are common or "ordinary" stockholders and when you read about share valuations, this is usually what is meant. Common shareholders have an ownership stake in the company. This comes with various rights including:
- The right to vote on major company decisions, such as board elections, or how to respond to a hostile takeover.
- The right to receive any common dividends the board declares.
- The right to participate in a distribution of assets when the company is liquidated.
Common shareholders also have the right to file a class action lawsuit against the company if there is an act of wrongdoing that potentially harms the company or negatively affects the value of its common shares. This enables them to exercise considerable control over how the company is managed and how it handles strategies for growth.
The Role of Preferred Stockholders
Preferred stockholders own a different type of share known as preferred stock. They have no voting rights, which means they cannot influence management decision-making.
What they do have is a guaranteed right to be paid a fixed amount of dividend every year and to receive this payment before the company pays a dividend to common shareholders. The amount of dividend is fixed or attaches to a specified interest rate; for example, a $10, 5 percent preference share would pay an annual dividend of 50 cents.
Both common stock and preferred stock can go up in value if the company is doing well. However, common stock is more volatile and tends to experience much larger capital gains – or losses – than preferred stock.
The right to receive a fixed dividend means that preferred stock behaves more like debt than a common share. Investors who wish to generate a predictable investment income rather than ride the volatility of the stock market typically choose to own preferred shares.
When the Company Experiences Problems
Besides voting rights, the major difference between common and preferred shareholders becomes apparent when the company is in distress. While the company is not obligated to make dividend payments to ordinary shareholders, it must still pay out on its preferred shares.
When there's no money in the coffers, the dividend becomes a liability which the company must honor at some point in the future. In liquidation, preferred shareholders receive their share of the company's assets after secured creditors and bondholders have been paid off but before common shareholders receive a cent – that's why these shareholders are called "preferred." Common shareholders are last in line. They receive nothing until all other claims have been fulfilled.