Do All Shareholders Receive Dividends? Understanding How Dividends Work
Besides having a fantastic product or service to render, companies need funds to start and thrive. In most cases, the funds come from investors who basically buy a chunk of company ownership. The chunk of ownership is known as shares, which are exchanged for investors' funding. But then, the funding in exchange for shares is technically a loan that “may yield interest”. How? Well, investors earn what’s known as dividends on the shares they hold.
Think of it like the company paying interest periodically for the loan capital. The interests or dividends must continue until the loan capital or shares are fully paid back. So, just as a loan yields interest, investing in a company by buying shares makes you entitled to dividends.
This article will cover:
What are dividends, and do all shareholders receive them
Different types of shares and the rights attached to each
Factors determining whether a shareholder receives dividends.
How company policies and decisions affect the distribution of dividends.
What Are Dividends?
For every investment, there is the expectation of “returns on investment (ROI)”. For investors who buy shares in a company, their ROI comes in the form of dividends. A dividend is a reward paid to shareholders for investing in a company. And this payment often happens at the end of a fiscal year.
In most cases, dividends are paid out of the company's net profits and sometimes paid even if the company fails to make profits. They could either be paid out in cash or reinvested as stock dividends. They could also be paid out as property dividends, in which company assets or properties are awarded to investors. Sometimes, companies may offer scrip dividends in place of stock, which are vouchers that can be redeemed at a later date for company shares on the market. In case of liquidation, where a company cannot pay out other forms of dividends, they may offer liquidating dividends, which are basically monies and assets leftover from settling debt and liabilities.
Ultimately, having a track record of consistently paying out dividends strengthens the company's perceived value in the market. This makes the company's stocks more attractive to investors. Dividends as a reward for investment create a win-win situation for the company and its shareholders. The shareholders can make profits over a long period of time, which is a form of passive income. On the other hand, the company enjoys funding, a potential increase in market value, and attracting new investors.
Types of Shares and Their Impact on Dividends
Without buying company shares, an investor cannot receive dividends. The amount and type of shares bought also determine how dividends will be paid. By default, substantial shareholders will enjoy higher dividend rates compared to persons who hold a few company shares. And some shareholders must be paid first before others.
There are three major types of company shares that can be bought:
Ordinary Shares
These are the most popular and easily accessible types of shares. Ordinary shares are usually given at the starting phase of a company. Founders, employees, and external investors are given ordinary shares to the extent of funding they provide. The more shares bought, the greater the ownership stake in the company. As such, shareholders in this category may either be substantial or minor. They have a right to vote on a decision to steer the company's direction.
Since ordinary shareholders are technically owners of the company, they have the right to share in the company's profit. Their share in the company's profit is paid out as dividends. However, ordinary shareholders aren't paid until after preferred shareholders are paid. If there isn't enough profit to pay dividends, the company may withhold the payouts and simply reinvest the funds for dividends back into the company until the next dividend payout date.
Preference Shares
When businesses start to scale, they often need more funding. To get the required funding, preference shares are issued. By definition, they’re superior to ordinary shares. Although preference shareholders usually do not have voting rights, they may vote in extreme circumstances such as liquidation or non-payment of dividends. Their superiority is that they're always served first during liquidation and dividend payments.
The company's articles of association often clearly highlight preference shareholders' rights to receive dividends before all other shareholders. Often, the dividends for preference shares are set at a fixed rate irrespective of subsequent market fluctuations.
Also, preference shareholders have the right to convert their shares into ordinary shares at an agreed price and date. This usually comes with the benefits accrued to ordinary shareholders, like voting rights and corporate management participation.
Non-Voting Shares
These shares have no voting rights. As such, shareholders cannot participate in determining the direction of the company during its general meetings. They are mostly issued to employees and family members of ordinary shareholders.
Due to their peculiar non-voting limit, companies can raise funds without diluting or complicating company control and management. Non-voting shareholders are entitled to dividends after other shareholders have been paid.
Dividend Policies and Company Decisions
A dividend policy is a document or company decision that outlines how a company will pay dividends to its shareholders. It usually specifies payout factors like dates, percentages, and hierarchy of shareholders to be paid. There are three main types of dividend policies: stable, constant, and residual policies.
A stable dividend policy is a simple policy that offers shareholders a predictable and more assured long-term payout arrangement for years. It is the most popular type of dividend policy.
A constant dividend policy offers short-term periodic payouts based on the company's market value. Hence, it's much more volatile, but the income stream is constant.
A residual dividend policy is an arrangement in which shareholders are paid dividends after the company has paid for its capital expenditures. Hence, there's less risk of increasing debt, but the income stream is unstable.
Do All Shareholders Get Dividends?
Every shareholder is entitled to dividends. However, some situations may warrant a company failing to pay or outright withholding dividends.
Conditions for Receiving Dividends
A few conditions must be met before shareholders may receive dividends. These include:
Payout Dates: Dividends are paid according to a strict calendar. Before payments can be made, dividends must first be declared and eligible shareholders recorded. Shareholders cannot demand a payout when it is not the payment date.
Profit Availability: Dividends are usually paid based on the profits the company makes. As such, when there's no profit, dividends cannot be paid. Only preference shareholders with cumulative dividends rights are protected against loss of dividends. In their case, unpaid dividends accumulate and are paid later when profit is realised.
Company Discretion: While it's expected that companies offering shares should pay dividends, some companies do not. The company dividend policy determines whether a company will pay dividends. Where a dividend policy does not offer dividend payout or specifies circumstances which may warrant withholding or non-payment of dividends, the policy will stand unless changed by votes.
Dividends Exclusion: Seeing as dividends are primarily based on profit and are paid in a hierarchy, there may be instances where certain shareholders might not receive dividends. For instance, where profit is insufficient to pay dividends to all classes of shareholders, the available profit shall cater to shareholders by hierarchy, starting with preference shareholders. The company reserves the right to reinvest the profit rather than distribute it as dividends to shareholders.
Where the conditions for receiving dividends aren't met, the company reserves the right to withhold paying dividends. In cases of financial constraints such as a lack of profit, the company dividend policy determines how dividends will be managed. It is up to the shareholders with voting rights to determine favourable conditions for paying out dividends that would protect the company's and its shareholders' interests.
How Dividends Are Declared and Paid
The payout of dividends follows a structured process with key dates that determine when dividends are declared, who is eligible, and when payments are made. Here’s an overview of how it works:
Declaration Date: This is when the company's board of directors announces the dividend, and it must be approved by the shareholders. Until the dividends are formally declared, the process cannot move forward. Declarations are made after the company has assessed its financial situation to ensure there is enough profit to distribute.
Ex-Dividend Date: The ex-dividend date is crucial because it determines who qualifies to receive the dividend. Only shareholders who have purchased shares before this date are eligible. Investors buying shares on or after this date will not receive the upcoming dividend. Think of it like an annual return—those who invested before a specific point in time are entitled to the return, while those who invest later must wait for the next cycle.
Record Date: The record date typically occurs two days after the ex-dividend date. This is the official cut-off date used by the company to compile the list of shareholders who are entitled to receive dividends. Only shareholders on record as of this date are eligible for the dividend payout.
Payment Date: This is when the dividend is actually paid out to eligible shareholders. The payment date usually follows the record date by about a month. Payments are typically handled by the company's securities depository, which disburses funds to brokerage firms where shareholders hold their accounts. The brokerages then either transfer cash dividends to the shareholders or reinvest the funds according to the shareholder's preferences. Preference shareholders are often paid first, followed by ordinary shareholders.
Tax Implications of Dividends
All income gets taxed. However, the tax rates vary, and there are circumstances where taxes may be waived. For dividends, tax may be waived if the dividend income falls within the amount stipulated as Personal Allowance (this is the amount of income you can earn per year without paying tax).
Also, dividends from shares in an Individual Savings Account (ISA) are not taxed. ISAs holding less than £20,000 are tax-free.
Having resolved the tax waivers, here are the tax rates that may apply to dividend income:
Taxes are charged based on income. The higher your income, the higher the tax. Income is usually categorised into three income tax bands: Basic, Higher, and Additional.
Currently, the tax rate per income tax band is as follows:
Income Class | Income Tax Band | Tax Rate on Dividends Above Dividend Allowance |
£12,571 to £50,270 | Basic Rate | 8.75% |
£50,271 to £125,140 | Higher Rate | 33.75% |
Above £125,140 | Additional Rate | 39.35% |
To calculate your tax band, add your total dividend income to your alternative income. You may have to pay taxes at various rates depending on your income class.
For clarity on paying dividends tax, you can reach out to HMRC’s helpline or fill out a self-assessment tax return. Alternatively, you can consult an investment and securities lawyer to accurately explain and calculate your taxes and file the returns with HMRC.
Common Challenges and Disputes
Seeing as most shareholders are neither employed nor involved in the direct management of a company, they may be out of touch with the financial realities of the company. As such, when issues such as dividend delays or non-payments occur, shareholders are often panicky. In some cases, the panic is justifiable, as the board of directors may fail to consider shareholders' recommendations on dividend payment. Sometimes, the board of directors may offer a dividend payment recommendation that is either too low or totally contrary to the dividend policy.
Whenever such challenges or disputes over dividends occur, the best course of action for shareholders is to file a claim for dividends. This basically seeks legal protection and enforcement of the dividend policy and shareholders' recommendations.
However, a dividend claim is only as strong as the unity of the shareholders and the evidence in support of the claim. Shareholders need to first agree to push for a dividend claim. Afterwards, the shareholders need to assess and attach the company dividend policy and other supporting documents like the articles of association to their claim. Formal or informal arrangements between the shareholders and the board of directors must be documented and filed alongside the claim for dividends.
Where there is a dividend policy, the board of directors may be legally forced to abide by it. However, in the absence of a dividend policy, the court may mandate the board of directors to consider the shareholders' recommendations on dividend payment.
The board of directors may only need to withhold dividends in extreme circumstances where the company’s finances are at risk. However, rather than acting arbitrarily, the board should reach a compromise with the shareholders concerning the dividend payment.
FAQs
What determines whether I receive a dividend?
You're only eligible for dividends if you're a shareholder in a company. Also, the company profit margin, your shareholding class, and ex-dividend date determine if you receive dividends as a shareholder. If you're a preference shareholder, you'll receive your dividend before all others - even when the company records little to no profit.
Can a company choose not to pay dividends?
Yes, a company can choose not to pay dividends depending on the circumstances. The company can opt to reinvest profit into the company to further strengthen its finance and market potential, which would yield better dividends at a later date.
How do preference shares affect my dividend rights?
Preference shares set you apart as a preferred shareholder, which means you'll be prioritised during dividends disbursement.
What happens if I sell my shares before the dividend payment date?
Shareholders who sell their shares before the ex-dividend date are ineligible for dividend payment. Hence, if you sell your shares after the ex-date but before the dividend payment date, you may be eligible for dividends.
Are dividends guaranteed for all shareholders?
No, peculiar circumstances such as company finance, low profit margin, liquidation, and even shareholders failing to meet the ex-dividend date, may prevent dividends from being distributable to all shareholders.
Conclusion
Dividends are a passive means of earning from a company without necessarily being employed there. All you need to do is buy shares and hold them until the dividend payment date. However, earning via dividends is not a stable income. Market fluctuations, company finance challenges, and payment eligibility may prevent a shareholder from being paid dividends.
At Lawhive, our expert solicitors help you make sense of your dividend entitlements, ensuring you get what’s rightfully yours. Whether you’re a preference shareholder or just curious about your rights, we’ll provide clear guidance and protect your financial interests. Contact us today for a consultation.