Ordinary vs Preference Shares in Australia: Key Differences

Thinking about raising capital or tidying up your company’s cap table? One of the earliest decisions you’ll face is whether to issue ordinary shares, preference shares, or a mix of both.

On paper, it sounds straightforward. In practice, the choice can shape control, dividends, and your exit outcomes for years. The good news is you have flexibility - as long as the rights are structured properly and recorded in the right company documents.

In this guide, we’ll break down ordinary shares vs preference shares in plain English, flag the key trade-offs for small businesses, and outline the legal steps to put your share classes in place in Australia.

What’s The Difference Between Ordinary And Preference Shares?

Shares are essentially a bundle of rights. Those rights usually sit across four buckets: voting, dividends, capital on exit, and information/protections. “Ordinary” and “preference” are just labels for different bundles.

Ordinary Shares

• Voting: Typically one vote per share on shareholder resolutions.
• Dividends: Paid at the directors’ discretion; no fixed entitlement.
• Capital: Rank behind creditors on a winding up and usually share pro‑rata after any preferences are paid.
• Simplicity: The default class for founders; clean and familiar to accountants, lenders and many investors.

Preference Shares

Preference shares are customised. They can include one or more of the following features to tilt risk and reward between founders and investors:

• Dividend preference: A fixed dividend rate or a priority over ordinary shares when dividends are declared.
• Liquidation preference: A right to be paid back (often the amount invested, sometimes with a multiple) before ordinary shareholders on a sale or winding up.
• Conversion: The right to convert into ordinary shares, often automatically on an IPO or approved exit.
• Redemption: The company (or holder) can redeem the shares after a set period or on certain triggers.
• Voting tweaks: Full voting, limited voting or no voting, plus “protective provisions” for key matters.

If you’re weighing up structures, it can help to first look at Different Classes Of Shares so you understand the menu of rights you can mix and match, and how Preference Shares are typically put together for Australian companies.

Common Preference Share Variations

• Cumulative vs non-cumulative dividends: Do unpaid dividends accrue to future years?
• Participating vs non-participating: Do holders take their liquidation preference and then also participate with ordinaries, or just the preference alone?
• Redeemable: Can the company buy the shares back at a fixed time/price (subject to Corporations Act requirements and solvency)?
• Convertible: Do they convert to ordinary shares (e.g. at a set ratio or on specific events)?

A Quick Example

Let’s say an investor tips in $500,000 on 1x non-participating preference shares with a 6% non-cumulative dividend and standard voting rights. On a sale, they’re first in line to get back their $500,000 before ordinary shareholders share the remainder. If no dividend is declared one year, it doesn’t accrue. That structure may suit a capital-protective investor and still leave upside for the founders.

Ordinary Vs Preference Shares: How Do You Choose?

There’s no one-size-fits-all answer. Your decision should reflect how you want to balance control, incentives and risk with co-founders and investors. Here are the key questions to work through.

1) How Important Is Control?

Ordinary shares generally carry straightforward voting rights. Preference shares can be structured with limited or no votes day-to-day, but with “veto” rights (protective provisions) on major matters like issuing new shares, selling the business or changing the constitution.

If founder control is a priority, you might prefer ordinary shares for founders and carefully scoped protective provisions for investors, rather than broad voting rights that could stall decisions.

2) What Returns Do Investors Expect?

Some investors, especially later-stage or capital-intensive backers, expect downside protection via a liquidation preference and dividend priority. Early-stage angels might be more comfortable with ordinary shares or simple, light-touch preferences.

Being clear on investor expectations early will save time and cost. Point them to a Preference Shares term summary if you need a common starting point for discussions.

3) Will You Raise More Capital Later?

Future rounds can layer multiple classes and preference stacks if you aren’t careful. Simple, well-drafted terms now will make later raises easier, especially if you plan to issue additional Different Classes Of Shares.

4) What’s Your Dividend Policy?

Many growing companies don’t pay dividends in the early years, so a fixed or cumulative dividend can build pressure on cash flow. Make sure any dividend obligation aligns with realistic forecasts and your obligations around Dividends in Australia.

5) Exit Scenarios And Founder Incentives

Liquidation preferences can change who gets what on a sale. A high multiple or participating preference may reduce ordinary shareholders’ upside, which can dampen founder motivation. Weigh the trade-off between attracting investment and preserving long-term incentives.

6) Valuation And Cap Table Clarity

Whether you opt for ordinary or preference shares, the price per share should align with a reasonable valuation methodology. This helps document the deal, manage tax considerations and keep your cap table clear. If you’re unsure where to start, read about Valuing Shares in a private Australian company.

How Do You Legally Create And Issue Share Classes In Australia?

Once you’ve settled the commercial terms, make sure the rights are enforceable and properly recorded. A clean process now avoids messy and expensive fixes later.

1) Check Your Constitution

Your company constitution needs to allow multiple classes and set out how new classes can be created and varied. If it’s silent, or you’re relying on replaceable rules, it’s usually best to update or adopt a tailored Company Constitution before issuing preference shares.

2) Document The Deal Between Founders/Investors

The rights should be mirrored in a term sheet and then in a formal Shareholders Agreement. That agreement typically covers decision-making, pre-emptive rights, drag and tag rights, information rights and how disputes are resolved.

3) Board And Shareholder Approvals

Directors should pass resolutions to issue the shares and approve the class rights. Depending on your constitution, you may also need a special resolution of shareholders to create or vary rights for a class.

4) Update Registers And Issue Certificates

Record the issue in your share register, including the class name, number of shares and price. Issue share certificates if required by your constitution and maintain accurate records from day one. Clean records make future raises, audits and exits much smoother.

5) Consider Corporations Act And ASIC Requirements

If you’re issuing shares for cash to a small number of investors without a prospectus, ensure you fall within the “small-scale offerings” pathway (often called the 20-investor/12-month, $2 million cap) under Section 708 of the Corporations Act. Also make sure you file any required ASIC updates on time and keep your statutory books up to date.

6) Price, Tax And Accounting

Work with your accountant on pricing, franking credits, dividend policy and classification of any redemption features. Getting the numbers right at issue time helps avoid later tax complexity.

Inside Preference Shares: Common Terms Explained

Here’s a plain-English explainer of the terms you’ll most often see in Australian preference share deals.

Liquidation Preference

Defines what preference holders receive on a sale or winding up before ordinary shareholders get anything. A “1x non-participating” preference pays back the original amount invested, then the rest goes to ordinaries. “Participating” means they also share pro-rata in the remaining proceeds.

Dividend Preference

Sets a priority or rate for dividends when declared. “Cumulative” means unpaid amounts roll forward; “non-cumulative” means missed amounts don’t accrue. Always balance this against cash flow and Australia’s rules around declaring Dividends.

Conversion

Allows preference shares to convert into ordinary shares (e.g., automatically on an IPO or by election on a sale). The conversion ratio and any anti-dilution protection should be clear, especially if later rounds are expected at a lower valuation (down rounds).

Redemption

Permits the company (or sometimes the holder) to redeem the shares after a set period, subject to solvency requirements. Redemption can be a useful “reset” if an exit hasn’t occurred, but must be carefully drafted to comply with the Corporations Act.

Voting And Protective Provisions

Preference shares might have limited votes day-to-day, but investors often negotiate veto rights on major actions like issuing new shares, changing the constitution, selling the business or incurring large debt. These guardrails are common in investment terms sheets.

Information Rights

Investors may require quarterly management reports or audited annuals. Make sure what you promise can be delivered without overloading your team.

Compliance, Risks And Best Practices

Structuring share classes isn’t just about the commercial deal - it also needs to stand up legally and operationally.

• Keep the constitution and shareholders agreement aligned: If there’s a mismatch between your class rights in the constitution and your Shareholders Agreement, you can end up with uncertainty (or disputes). Ensure the documents speak the same language.
• Mind the fundraising rules: If you’re relying on the small-scale offerings exemption under Section 708, track investor numbers and amounts carefully and include the right investor acknowledgements in your subscription documents.
• Stay solvent and papered up: Don’t agree to dividend or redemption terms that could pressure solvency. Keep board minutes, registers and certificates in order. This record-keeping matters when you raise further capital or sell.
• Think ahead to later rounds: Complex, heavily participating preferences can create “overhang” that scares off later investors. Simple, standardised terms are often easier to build on.
• Employee incentives: If employee ownership is part of your strategy, preference shares are usually not the vehicle. Consider options under an Employee Share Option Plan and keep your ordinary share pool clear for employee equity.

Step-By-Step: A Practical Roadmap To Issuing Share Classes

When you’re ready to proceed, this sequence keeps things simple and compliant.

1. Plan your cap table: Decide how many ordinary vs preference shares you’ll issue now and leave room for future issues. Align this with a sensible valuation; if needed, revisit how you’re Valuing Shares.
2. Update governance: Review and, if needed, adopt a tailored Company Constitution that supports classes and sets clear mechanics for creating/varying rights.
3. Lock in the deal: Finalise a term sheet and then a formal Shareholders Agreement that mirrors the commercial terms and adds decision-making, transfer restrictions and dispute resolution.
4. Approve and issue: Pass board/shareholder resolutions, issue shares, update the register and minute everything. Set up your dividend, conversion and redemption tracking (even if you don’t expect to use them soon).
5. Compliance check: Confirm you’re within Section 708 or other fundraising pathways, and set calendar reminders for ASIC deadlines.
6. Operationalise: Put in place simple reporting to meet any investor information rights and ensure your finance function can handle dividend calculations if they become payable.

Key Takeaways

• Ordinary vs preference shares is really a question of which bundle of rights best aligns control, cash flow and exit outcomes for your business and investors.
• Preference shares can include dividend priority, liquidation preference, conversion, redemption and protective provisions - useful tools if they’re kept clear and balanced.
• Make sure your class rights are properly baked into a modern Company Constitution and a tailored Shareholders Agreement.
• Plan ahead for future raises: avoid unnecessarily complex preferences that can deter later investors or skew founder incentives.
• Keep compliance tight: rely on the appropriate pathway under Section 708, minute approvals, maintain registers and understand your obligations around Dividends.
• Get the pricing and paperwork right from day one; sound valuation and clean records make future raises and exits faster and less costly.

If you’d like a consultation on structuring ordinary shares vs preference shares for your company, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.