Deferred Share

Published Apr 7, 2024

Definition of Deferred Share

A deferred share is a type of equity security that does not provide immediate rights to dividends or voting in shareholder meetings upon issuance. Instead, these rights are deferred to a later specified date or until certain conditions are met. Typically, deferred shares are used by companies as a form of long-term incentive compensation for employees or as a strategy to deter hostile takeovers.

Example

Consider a startup tech company, InnovateTech, planning to reward its employees with shares as a part of their compensation package. However, due to its early stage, the company needs to conserve cash to fund its growth. Instead of offering standard shares or immediate financial bonuses, InnovateTech decides to grant its employees deferred shares. These shares will vest after a period of five years, meaning the employees will only gain voting rights and start receiving dividends after this period. This arrangement motivates employees to stay with the company and contribute to its long-term success.

Why Deferred Shares Matter

Deferred shares represent a strategic approach to achieve several key business goals:

• Incentivizing Employees: By aligning employee compensation with the long-term performance of the company, deferred shares can enhance loyalty and motivation among the workforce. Employees are more likely to stay with a company if they stand to gain significant financial benefits in the future.
• Financing: For startups and growing firms, offering deferred shares allows them to conserve cash that would otherwise be paid out as dividends. This cash can be reinvested into the company to fuel growth and expansion.
• Deterrent to Takeovers: Companies may use deferred shares with certain restrictions to make hostile takeovers more difficult. By granting deferred shares with voting rights that activate under specific conditions, such as a takeover attempt, companies can create a deterrent for unwelcome acquisition attempts.

Frequently Asked Questions (FAQ)

What are the key differences between deferred shares and traditional shares?

Deferred shares differ from traditional shares primarily in their lack of immediate dividend rights and voting power. While traditional shares grant these rights upon issuance, deferred shares withhold them until a certain date or milestone is reached. Additionally, the conditions associated with deferred shares can be tailored to meet specific strategic goals of the issuing company.

What are the potential downsides to employees holding deferred shares?

The main downside for employees is the risk associated with the long-term nature of the reward. If the company fails to perform well, the value of the deferred shares could be significantly lower than expected, or the company might not survive long enough for the shares to vest. Moreover, the lack of immediate voting rights means employees have no say in company decisions during the deferment period.

How do deferred shares impact company valuation?

From an accounting perspective, deferred shares are considered part of a company’s equity and can affect its valuation by increasing the shareholders’ equity section of the balance sheet once vested. However, until they vest, their treatment can vary depending on the specific accounting standards applied. For investors, the dilution effect of eventual vesting and conversion into common shares can impact the perception of a company’s value, as future earnings will have to be distributed across a larger number of shares.

In conclusion, deferred shares serve as a critical tool for companies looking to align the interests of employees with those of the organization, conserve cash, and protect against hostile takeover attempts. However, both issuing companies and the recipients of deferred shares need to carefully consider the associated risks and benefits.