What Is a Deferred Share?
A deferred share is a share that does not have any rights to the assets of a company undergoing bankruptcy until all common and preferred shareholders are paid. It may also be a share that is issued to company founders that restricts their receipt of dividends until dividends have been distributed to all other classes of shareholders. Deferred shares can also be awarded to venture capital and other private investor groups as part of a long-term investment in a company.
- Deferred shares are the last in line in credit or bankruptcy proceedings, following preferred and common stockholders.
- Deferred shares are usually reserved for company insiders and investors, with various term stipulations about when the shares vest, and may be convertible to either common stock or another class of stock.
- The idea is to keep company management and investors intact through a company’s evolution, from a start-up to a publicly-traded company.
- Deferred shares are less common, with restricted stock units (RSU’s) becoming increasingly common due to their shorter vesting period.
- Either way, deferred shares represent a long-term compensation award for company founders, executives, and initial investors.
Understanding a Deferred Share
Deferred shares—a method of stock payment to directors and executives of a company—are deposited into a locked account. The value of these shares fluctuates with the market and cannot be accessed by the beneficiary for the purpose of liquidation until they are no longer employees of the company. This also applies if a particular date has passed and the employee is considered fully vested with the company. Subordinate to all other classes of common and preferred stock, these shares are last in line when a company goes bankrupt and liquidates all assets.
While deferred stock represents a particular cash value based on market conditions, phantom stocks don't allow for payment in cash. Also, rather than actual deposits of securities, companies sometimes maintain bookkeeping entries of cash equaling an offsetting security position. When the executive or director leaves the company, the cash is converted into stocks at market value.
Deferred shares are mostly used as a method of compensation for executives and founders of a company or a means to induce investors to invest in a company. Deferred shares come with many restrictions, such as vesting periods, company performance, the market price of the stock, and others.
Traditionally, deferred shares are just part of a larger compensation plan. Employees being issued deferred stock may also receive more traditional stock options, which may be subject to certain vesting periods, as well as other investment or retirement options.
No longer commonly used, deferred shares provided their holders with large dividend payouts; typically higher than the average rate offered on other forms of shares, but are only paid after all other classes of shareholders have received their distributions. Holders of deferred shares have access to all the remaining profits after all of the other obligations are met.
Deferred Shares vs. Restricted Shares
Restricted stocks are those that have specified limits with regard to the ability of the employee to monetize or access the stocks. While both deferred and restricted stocks may be subject to vesting requirements, resulting in a delay before the employee takes full ownership of the associated shares, restricted stocks are immediately converted to unrestricted shares once the period has ended, while deferred shares do not convert until a selected date beyond the vesting date. For either deferred or restricted shares, employees who end their employment before the vesting period has ended, forfeit all rights to the shares in question.
When a company is liquidated because it goes bankrupt, there is a payment structure defined by law that determines which creditors are paid first when a company's assets are liquidated for cash. Those who are paid first are always secured creditors. These are individuals that have loaned money to the company with assigned collateral. This also includes secured bondholders.
After secured creditors, next in line are unsecured creditors. These are creditors who have made loans without any collateral backing the loan, but it also includes employees and suppliers that are owed money. It is a larger group that in some manner is owed money by the company.
Last in line are stockholders. This includes preferred and common stockholders, and the last, which would be deferred stockholders.