Preference Shares

Preference shares are typically stock option that allows shareholders to receive dividends before the equity shareholders. However, preference shares are not allotted to the general public.

Preference shares provide both the investor and the business with numerous advantages. For the investor, preference shares provide a fixed income and are often less risky than other investments. For the company, preference shares offer a way to raise capital without taking on debt.

This article will explain the meaning of preference shares.

What is the meaning of preference shares?

Preference shares meaning is that it is a type of equity share that provides certain preferential rights to the shareholders, in terms of dividends and assets, compared to the ordinary shareholders.

The advantages of preference shares are that it offers preferential rights, including the right to a fixed rate of dividend payment before any dividend payment to regular shareholders and the right to the firm’s assets in the case of bankruptcy after the creditors.

However, it does not come with voting rights like common equity shareholders.

What are the attributes of preference shares?

Some attributes of preference share capital include:

  • Preference shares are also known as hybrid securities as they combine the features of both debt and equity.
  • Preference shares have a claim on a company’s assets that is senior to that of common stockholders but is subordinate to that of the company’s creditors. In other words, in the event of liquidation, preference shareholders are entitled to be paid their share of the company’s assets before common shareholders but after creditors.
  • Every corporation must issue convertible shares, and preference owners can benefit from changing their preferred stocks into ordinary shares.
  • Typically, preference shares lack voting rights. However, they could also be granted other benefits, such as the right to collect dividends before regular shareholders or to get paid first in the case of a liquidation.

How are preference shares classified?

Let's take a quick look at the types of preference shares.

  • Cumulative preference share

    With cumulative preference shares, shareholders can receive dividends for every year in which they could not do so owing to a lack of adequate profits. For instance, if a corporation does not generate enough profit in a given year, it will not distribute any dividends in that year but instead, pay arrears on cumulative dividends in the next year.
  • Non-cumulative preference shares

    These shares do not build up arrears of dividend payments. Non-cumulative preference shares receive dividends from the company’s profits only for the current year. The stockholders are not paid any dividends during a year in which the business is not profitable, and they are also ineligible to receive dividends in any subsequent profitable years.
  • Redeemable preference shares

    Shares that can be redeemed by the issuing business within 20 days of the issuance date to meet their objectives are redeemable preference shares.
  • Non-redeemable preference shares

    These are not redeemable at any point throughout the company’s existence and are known as non-redeemable preference shares. These shares can only be redeemed when the firm is wound up.
  • Convertible preference shares

    Convertible preference shares allow owners to convert their preference shares into equity shares at a predetermined rate following the expiration of a defined period as stipulated in the memorandum.
  • Non-convertible preference shares

    Shares that cannot be converted into common shares are known as non-convertible shares. However, they still do have preference rights when it comes to capital payments if the company is wound up.
  • Participating preference shares

    These shareholders have the right to receive a part of the surplus profit if the company files for bankruptcy. The profit will only be received after paying the dividends to other shareholders.
  • Non-participating preference shares

    In non-participating preference shares, shareholders are not entitled to extra profits in the event of liquidation.

Preference shares example

Let’s say “ABC Company” has 5000 preference shares in total to distribute to its stockholders. These shares have a price of Rs. 100 and earn interest at a rate of 7% annually. Due to certain circumstances, the company was not able to allocate dividends to its preferred shareholders in 2019 and 2020.

The preference shareholders are entitled to receive Rs. 1,05,000 by the end of 2021 before the corporation may pay its ordinary shareholders. This sum is the cumulative dividend that all stockholders have received after three years. This is an advantage of preference shares. To summarise, investors must thoroughly grasp the various stock market shares and preference stock meanings. Individuals can choose their investment avenues depending on their objectives and risk tolerance.

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