A deferred share is a method of providing an investor with stake in a company; however, the nature of the share restricts the rights of the investor on the assets of the company until the company pays all mandatory creditors. The category of mandatory investors includes trade payables, financial institutions and preferred stockholders. Deferred shareholders get whatever remains after liquidating the company and paying off company debts.
Deferred shares are generally issued by companies undergoing capital restructuring processes. Capital restructuring occurs when a company’s capital position or its debt-to-equity ratio must be changed in response to changing business or market conditions. Organizations also use capital restructuring as part of a long-term strategy to make the company viable and sustainable. In such cases, a company may issue deferred shares. Because of having limited rights, these shares are or may become of negligible value with time. Deferred shares are ultimately cancelled so as to have a more adequate equity position.
Those holding deferred shares have very limited rights as compared with those with ordinary shares. For example, deferred shareholders cannot vote on company matters such as election and dismissal of staff. If the company enters bankruptcy proceedings, deferred shareholders are last on the list of claims that must be paid. These shares are also not tradable until a certain date. For example, when companies give the shares as benefits to employees, the employees cannot trade the shares until they terminate their employment with the company.
An example of a deferred share is the PIB, “Permanent Interest Bearing” shares. Building societies issue these shares, and they generally offer a competitive interest rate. PIB shares can be irredeemable, or you may redeem them after an extremely extensive period from the issuing date of the share. Because of the extended period, the PIBs carry with them an element of inherent interest rate risk. Since the share is long-term, frequent fluctuations in interest rates can lead to a reduction in the price of the share.
Deferred shares may be issued as part of an employee benefit package, but there is potential for abuse because the company may issue ordinary and deferred shares. The value of the deferred shares would be much less than the value of the ordinary shares. In this scenario, both classes of shares are merged to form one single group of shareholders. The value of the deferred shares, therefore, would increase regardless of the performance of the company simply because of the merger between the two classes of shares.