Deferred Shares, also called founders’ shares or management shares, are a special class of shares whose dividend rights are postponed until other shareholders have received their payments. They are usually issued to promoters, founders, or Directors as a reward for their role in starting the company. Holders receive dividends only after Preference and ordinary shareholders are paid a stated rate, but may then share heavily in the surplus profits. Their face value is often small, though the return can be large in a successful business. Common in the UK, they are rare in India, since the Companies Act, 2013 does not recognise this class of equity.
What are the Importance of Deferred Shares?
1. Useful for Promoters and Founders
Deferred shares are mainly issued to promoters and founders of the company as a reward for their efforts in establishing the business. They are also called founders’ shares. Promoters take high risk in starting the company, arranging capital, and managing initial difficulties. Deferred shares give them a special benefit because they get dividend only after other shareholders, but they may get a higher rate later. This encourages promoters to work hard for the success of the company. It recognizes their contribution and entrepreneurial role in the formation and growth of the business.
2. Provides Long-Term Capital
Deferred shares provide long-term capital to the company. Like equity shares, the capital raised through deferred shares is permanent and need not be repaid during the lifetime of the company. The company can use this capital for purchase of fixed assets, expansion, and working capital. Since dividend on deferred shares is paid last, the company gets relief during initial years when profit is low. This helps the company in stabilizing its operations. Deferred shares thus strengthen the financial base of the company and support its long-term growth and development.
3. Helps in Raising Capital Without Immediate Burden
Deferred shares help the company in raising capital without immediate burden of dividend. Dividend on deferred shares is paid only after paying dividend to equity and preference shareholders. In the early years, when profit is low, the company can pay less or no dividend to deferred shareholders. This reduces financial pressure. The company can use profit for growth and development. This feature is very useful for new companies which need funds but cannot pay regular dividend. It gives flexibility to the management in distribution of profit and financial planning.
4. Encourages Promoters to Work Efficiently
Deferred shares encourage promoters to work efficiently because their dividend depends on the profit of the company after paying others. If the company performs well, they get good dividend; if it performs poorly, they get nothing. This links their reward directly with the success of the company. Promoters will try to increase profit, reduce cost, and improve efficiency to get higher return. This creates a sense of responsibility and motivation. It aligns the interest of promoters with the interest of other shareholders and helps in achieving overall growth of the firm.
5. Maintains Control with Promoters
Deferred shares help promoters in maintaining control over the company. Deferred shareholders often get extra voting rights or special rights in management. Even with a small investment, promoters can control the affairs of the company. This ensures that the original founders can guide the company according to their vision. It prevents takeover by outsiders. Maintaining control helps in stable management and long-term planning. However, this control should be used responsibly in the interest of all shareholders. It gives promoters the power to protect their founder’s vision and business ideas.
6. Attracts Investors by Showing Promoter Confidence
Issue of deferred shares shows the confidence of promoters in the company. When promoters accept shares on which dividend is paid last, it signals to the public that they believe in the future success of the company. This increases trust among investors, banks, and creditors. Public feels safe to invest in such a company. It improves the reputation and goodwill of the firm. This confidence helps the company in raising further capital easily. Deferred shares thus act as a signal of promoter commitment and long-term faith in the business.
What is the Process of Issuing Deferred Shares?
1. Decision by Board and Promoters
The process starts with the decision of the Board of Directors and promoters to issue deferred shares. Deferred shares are generally issued to founders for their services, efforts, and contribution in forming the company. The board decides the number of deferred shares, face value, and terms of issue. It checks whether the Articles of Association allow the issue of deferred shares. Approval is taken from existing shareholders in a general meeting. This decision stage is important because deferred shares have special rights regarding dividend and voting. Proper planning ensures that the rights of other shareholders are protected.
2. Approval and Compliance with Law
After decision, the company must take approval as per the Companies Act and other legal provisions. Deferred shares can be issued only if authorized by the Memorandum and Articles of Association. The company must comply with SEBI guidelines and file necessary documents with the Registrar of Companies. The terms of issue, like rate of dividend and voting rights, must be clearly mentioned. Legal compliance ensures transparency and protects the interests of all shareholders. Without proper approval, the issue of deferred shares can be declared invalid. Therefore, legal formalities must be completed carefully before proceeding further.
3. Valuation of Promoters’ Services
Deferred shares are often issued in return for the services of promoters, not for cash. Therefore, the value of promoters’ services must be properly evaluated. Experts may be appointed to value the contribution of promoters in terms of idea, time, and efforts. The board decides how many deferred shares should be given for such services. This valuation must be fair and reasonable. Over-valuation may harm the interests of other shareholders. Proper valuation ensures that promoters get fair reward and the company gets proper capital. It also maintains transparency in the issue process.
4. Issue of Prospectus or Offer Document
The company prepares a prospectus or offer document containing details of deferred shares. It mentions the number of shares, rights of deferred shareholders, terms of dividend, and voting rights. It also discloses the reason for issue and the benefit to the company. The prospectus is filed with the Registrar of Companies. In case of private placement to promoters, a private offer letter is issued. This document informs all stakeholders about the special nature of deferred shares. Proper disclosure helps in avoiding disputes and builds trust among shareholders and investors.
5. Allotment and Issue of Certificates
After completing formalities, the board approves the allotment of deferred shares to promoters. Allotment letters are issued and entries are made in the Register of Members. The company issues share certificates or credits shares in demat accounts. Deferred shareholders become members of the company and get rights as per the terms of issue. The company must inform the Registrar about allotment within the prescribed time. This final step completes the process. Proper record-keeping ensures legal validity of the issue and protects the rights of deferred shareholders in future.
What is the Repayment / Redemption of Deferred Shares?
Redemption of deferred shares means repayment of capital to deferred shareholders and cancellation of their shares. Deferred shares are generally permanent, but they can be redeemed if the terms of issue allow it. Redemption means the company buys back the shares and returns the money to holders. After redemption, deferred shareholders cease to be members. The company must follow the terms mentioned in the Articles of Association and the issue document. Redemption reduces the capital of the company and also reduces the burden of dividend. It is done only when the company has sufficient funds and legal approval.
Conditions for Redemption of Deferred Shares:
1. Authorised by Articles of Association
Redemption is possible only if it is authorised by the Articles of Association of the company. If the Articles do not permit redemption, the company cannot redeem deferred shares. In such case, the Articles must first be altered by passing a special resolution in the general meeting. This condition ensures that redemption is done according to the rules agreed at the time of formation. It protects the rights of all shareholders. The company must carefully check its Articles before starting the redemption process. Without this authorization, any redemption will be considered illegal and invalid in the eyes of law.
2. Shares Must Be Fully Paid-Up
Only fully paid-up deferred shares can be redeemed. If shares are partly paid, the company must first call the unpaid amount from shareholders and make them fully paid. This condition ensures that the company receives full capital before repayment. It also protects creditors because redemption of partly paid shares would reduce capital without full receipt. The board must verify that all calls have been paid. If any shareholder has not paid, the company must take action to recover the amount. This condition maintains financial discipline and ensures fair treatment to all shareholders and creditors.
3. Approval of Shareholders
Redemption requires prior approval of shareholders in a general meeting. The company must pass a special resolution approving the redemption, its terms, and its timing. This approval ensures that shareholders are aware of the effect of redemption on capital structure and dividend. It also prevents management from taking arbitrary decisions. The resolution must mention the number of shares to be redeemed and the source of funds. Without shareholder approval, redemption cannot be done. This condition promotes democratic control and transparency in the management of the company.
4. Redemption Out of Profits or Fresh Issue
Redemption must be made either out of profits available for dividend or out of proceeds of a fresh issue of shares. It cannot be made out of capital unless permitted by law. If redemption is made out of profits, an equal amount must be transferred to Capital Redemption Reserve Account. This reserve maintains the capital base of the company. If redemption is made out of fresh issue, the new shares provide funds for repayment. This condition ensures that the company’s capital is not reduced to the harm of creditors and financial stability is maintained.
5. Solvency and Protection of Creditors
The company must be solvent at the time of redemption. It must be able to pay its debts and liabilities after redemption. Redemption should not affect the ability of the company to pay creditors, debenture holders, and other stakeholders. The directors must ensure that after redemption, the company will have sufficient working capital for smooth operations. This condition protects creditors from loss. If the company is in financial difficulty, redemption should be postponed. Maintaining solvency is essential for the survival and goodwill of the company after redemption of deferred shares.
What is the Legal Framework for Deferred Shares in India (Companies Act, 2013)?
The Companies Act, 2013 has made a major change regarding deferred shares in India. Under Section 43 of the Act, a company limited by shares can issue only two types of shares – equity shares and preference shares. The Act does not permit the issue of deferred shares or founders’ shares after its commencement. This was done to protect the interests of ordinary shareholders and to ensure equality among all shareholders. Earlier, under the Companies Act, 1956, companies could issue deferred shares to promoters with special rights regarding dividend and voting, but this often led to misuse of power and unfair advantage to promoters. The 2013 Act abolished this practice to promote transparency, fairness, and good corporate governance. However, deferred shares already issued before the commencement of the Act are allowed to continue as per their old terms, but no new deferred shares can be issued. The Act also provides rules for issue, rights, and redemption of equity and preference shares, and requires companies to follow SEBI guidelines and file necessary documents with the Registrar of Companies.
What are the Advantages of Deferred Shares for Companies?
1. Easy Capital for New Companies
Deferred shares help new companies in raising capital easily. In the initial stage, promoters contribute their ideas, efforts, and services to form the company. Instead of paying cash, the company issues deferred shares to them. This provides capital without immediate cash outflow. The company can use its cash for business operations, purchase of assets, and working capital. It is especially useful for companies which do not have enough funds in the beginning. By issuing deferred shares, the company can start its business smoothly and build a strong financial base for future growth and expansion.
2. No Immediate Dividend Burden
Deferred shares do not create an immediate dividend burden for the company. Dividend on deferred shares is paid only after paying dividend to preference and equity shareholders. In the early years, when profit is low, the company can skip or pay very low dividend to deferred shareholders. This gives financial relief and flexibility to the management. The company can retain profit for growth, expansion, and repayment of debt. This feature is very helpful for new and growing companies. It ensures that the company does not face liquidity problems due to compulsory dividend payment in difficult times.
3. Encourages Promoters’ Efforts
Deferred shares encourage promoters to work hard because their return depends on the success of the company. Since they get dividend last, they will try to increase profit so that after paying others, sufficient profit remains for them. This motivates them to manage efficiently, reduce cost, and take correct decisions. It creates a direct link between promoters’ reward and company’s performance. This encouragement leads to better management and higher productivity. Promoters feel responsible for the growth of the company. Thus, deferred shares act as a powerful incentive for promoters to work sincerely.
4. Helps in Maintaining Promoters’ Control
Deferred shares help the company in maintaining control with promoters. Deferred shareholders often enjoy special voting rights, which allow promoters to control the management even with small investment. This ensures stable leadership and continuity of the original vision. It prevents outsiders from taking over the company easily. Stable control helps in taking long-term decisions without pressure from short-term investors. It also protects the company’s policies and goodwill. However, control should be used in the interest of all shareholders. This control feature is a major advantage of deferred shares for companies.
5. Improves Financial Stability
Deferred shares improve the financial stability of the company. The capital raised through deferred shares is permanent and need not be repaid. It acts as a cushion to absorb losses and face difficult situations. It strengthens the equity base and improves the creditworthiness of the company. Banks and creditors feel safe to lend money to such a company. A strong capital base helps the company in getting loans at lower interest. It also helps in maintaining a balanced capital structure. Thus, deferred shares contribute to the long-term stability and survival of the company.
6. Attracts Public Confidence
Issue of deferred shares to promoters increases public confidence in the company. When promoters accept shares on which dividend is paid last, it shows their faith in the future of the company. The public feels that promoters are confident about earning high profits. This builds trust and goodwill. Investors, banks, and suppliers become ready to invest and give credit. It improves the reputation of the company in the market. This confidence helps the company in raising further capital easily through equity shares and debentures. Thus, deferred shares act as a signal of promoter commitment.
What are the Limitations of Deferred Shares for Companies?
1. Unfair Advantage to Promoters
Deferred shares give unfair advantage to promoters. Promoters get special voting rights and control over the company even with small investment. They may get higher dividend in later years after the company becomes profitable. This creates inequality between promoters and ordinary shareholders. Ordinary shareholders may feel cheated because they bear risk but promoters enjoy more power. This unfairness reduces trust and confidence of investors. It may also lead to disputes among shareholders. Due to this reason, the Companies Act, 2013 has prohibited the issue of new deferred shares in India to ensure equality and fairness.
2. Misuse of Power by Promoters
Deferred shares can lead to misuse of power by promoters. Since promoters have extra voting rights and control, they may take decisions for personal benefit instead of the interest of the company. They may appoint their relatives, pay high remuneration to themselves, or divert company funds. Ordinary shareholders cannot easily oppose them due to lack of voting power. This misuse can harm the company and reduce its profitability. It also damages the reputation of the firm. Lack of proper checks on promoters’ power is a serious limitation of deferred shares for companies.
3. Reduces Investor Confidence
Deferred shares reduce investor confidence in the company. When public investors see that promoters enjoy special rights, they feel that their interests are not protected. They may hesitate to invest in such companies. They fear that promoters will take all benefits and leave little for ordinary shareholders. This reduces the demand for shares and lowers the market price. It also makes it difficult for the company to raise further capital. Investors prefer companies where all shareholders are treated equally. Therefore, deferred shares can harm the goodwill and image of the company in the capital market.
4. Complex and Costly Management
Management of deferred shares is complex and costly. The company has to maintain separate records, calculate dividend in a particular order, and follow special rules for voting rights. This increases administrative work and legal formalities. Disputes may arise regarding the rights of deferred shareholders and the amount of dividend payable to them. The company may have to take legal advice frequently. This complexity increases cost and time. Small companies find it difficult to manage deferred shares. Due to this complexity, most companies prefer simple equity shares instead of deferred shares for raising capital.
5. Not Suitable for Modern Companies
Deferred shares are not suitable for modern companies which follow principles of good corporate governance and equality. Modern investors want transparency, equal rights, and democratic management. Deferred shares go against these principles by giving special privileges to a few persons. They also create confusion in capital structure. With the growth of SEBI regulations and corporate governance norms, deferred shares have become outdated. The Companies Act, 2013 has banned new deferred shares. Modern companies now use equity shares, stock options, and other incentives to reward promoters instead of deferred shares.
6. Difficulty in Redemption and Valuation
Redemption and valuation of deferred shares are difficult. Since deferred shares are issued for promoters’ services and not for cash, it is hard to determine their correct value. At the time of redemption, disputes may arise about the amount payable. If the company wants to redeem them, it needs to follow complex legal procedures. Valuation of services is subjective and may be challenged by other shareholders. This creates legal problems and delays. Difficulty in valuation and redemption makes deferred shares an unattractive and problematic source of finance for companies.
Why are Deferred Shares Rarely Used in Modern Companies?
1. Prohibited by Companies Act, 2013
The main reason is that deferred shares are prohibited by the Companies Act, 2013 in India. Under Section 43 of the Act, a company can issue only equity shares and preference shares. It cannot issue deferred shares or founders’ shares. This legal ban was imposed to ensure equality among shareholders and to prevent misuse of power by promoters. Companies which violate this provision face legal action and penalty. Due to this legal restriction, modern companies cannot use deferred shares even if they want to. They have to use other methods like stock options to reward promoters.
2. Against Principle of Equality
Deferred shares are against the principle of equality among shareholders. They give special rights and extra voting power to promoters, while ordinary shareholders get less rights. Modern corporate governance emphasizes equal treatment, fairness, and democracy. Investors do not like companies where a few persons enjoy special privileges. They prefer companies where all shareholders have equal rights. Deferred shares create inequality and dissatisfaction. Therefore, modern companies avoid deferred shares to maintain equality, transparency, and trust among all shareholders and stakeholders.
3. Reduces Investor Confidence
Deferred shares reduce investor confidence because investors feel that promoters will take undue advantage. When promoters have special voting rights, ordinary investors fear that their interests will be ignored. They may not invest in such companies. This makes it difficult for the company to raise capital from the public. In today’s competitive capital market, investor confidence is very important. Companies need to attract domestic and foreign investors. By avoiding deferred shares, companies can build trust and improve their reputation in the market. Therefore, deferred shares are rarely used now.
4. Better Alternatives Available
Modern companies have better alternatives to reward promoters instead of deferred shares. They can use Employee Stock Option Plans (ESOPs), sweat equity shares, performance-based bonuses, and profit-sharing schemes. These alternatives are more transparent, fair, and legally accepted. Sweat equity shares are issued to promoters for their technical knowledge and services, but with equal rights. ESOPs motivate employees without creating inequality. These modern methods are flexible and easy to manage. Due to availability of these better alternatives, companies do not need to issue deferred shares anymore.
5. Complexity and Disputes
Deferred shares create complexity and disputes in management. Calculation of dividend, voting rights, and redemption of deferred shares is complicated. Different shareholders may interpret the terms differently, leading to legal disputes. The company has to maintain separate records and follow special procedures. This increases cost and administrative burden. Modern companies prefer simple capital structures with only equity and preference shares. Simplicity helps in easy management, clear reporting, and better decision making. Due to complexity and chances of disputes, deferred shares are avoided by modern companies.
6. Focus on Good Corporate Governance
Modern companies focus on good corporate governance, transparency, and accountability. SEBI and other regulators have fixed strict rules for governance, disclosure, and protection of minority shareholders. Deferred shares go against these norms because they concentrate power in the hands of a few promoters. They reduce accountability and increase chances of fraud. Companies which follow good governance get higher valuation and attract institutional investors. To maintain good governance, companies avoid deferred shares and ensure that all shareholders are treated equally and fairly in all matters.
Who are Deferred Shareholders and what are their Rights?
Deferred shareholders are the promoters and founders of the company who are issued deferred shares for their services, efforts, and contribution in forming the company. They are also called founders’ shareholders. They do not pay cash for shares; instead, they provide their ideas, technical knowledge, time, and hard work. They take the initial risk in starting the business. In return, the company issues them deferred shares with special terms. Their position is different from ordinary shareholders because their dividend is paid last. They are considered the original owners who laid the foundation of the company.
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Right to Dividend – Paid Last
Deferred shareholders have the right to dividend, but their dividend is paid last. First, dividend is paid to preference shareholders, then to equity shareholders, and only after that, if profit remains, dividend is paid to deferred shareholders. In the early years, they may get no dividend because profit is low. But in later years, when profit is high, they may get dividend at a higher rate. This right links their income with the success of the company. It motivates them to work hard for increasing profit and growth of the business.
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Right to Vote and Control
Deferred shareholders generally enjoy special voting rights and control over the company. They may get more than one vote per share or have the right to appoint directors. This gives them power to control the management and policies of the company. Even with a small number of shares, they can influence decisions. This right ensures that promoters can guide the company according to their original vision. However, this extra control should be used in the interest of all shareholders. It gives deferred shareholders a dominant position in the management of the company.
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Right to Share in Assets on Winding Up
On winding up of the company, deferred shareholders have the right to share in the remaining assets, but they are paid after preference and equity shareholders. They get the residual assets if anything remains. If the company has grown and accumulated large assets, they may get a good amount. This right is similar to their dividend right – they are paid last. It shows that they bear maximum risk. This right makes them true risk bearers. It also motivates them to build a strong company with valuable assets for long-term benefit.
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Right to Inspect Books and Attend Meetings
Deferred shareholders have the right to attend general meetings and inspect books of accounts, registers, and records of the company. They can ask questions about the performance and financial position of the company. They can also vote on important matters. This right ensures transparency and allows them to protect their interests. They can participate in discussions and give suggestions for improvement. Like other shareholders, they have the right to receive annual reports and notices of meetings. This right makes them active members of the company, not just silent investors.
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Right to Transfer Shares
Deferred shareholders have the right to transfer their shares, subject to the terms of issue and Articles of Association. They can sell or transfer their shares to another person, but sometimes prior approval of the board is required. Transfer of shares allows them to convert their investment into cash when needed. However, transfer may affect control of the company if shares go to outsiders. Therefore, the company may put restrictions on transfer to maintain promoters’ control. This right provides liquidity and flexibility to deferred shareholders while protecting the company’s stability.
