A company that wants to expand needs capital to invest. It raises capital by offering securities to public investors, institutions, and organizations. These securities are of various types. Investors can choose any form of security depending on the benefit they seek to enjoy from investing. These securities have a financial value that depends on the company’s performance.
They represent direct or indirect ownership of the company depending on how they are designed and the associated terms and conditions. A company can choose the type of securities it can offer and a certain quantum of the capital raised in the form of share capital. The main types of shares offered are Equity and Preference. This article defines preference shares.
What do you mean by preference shares
A company issues Preference shares to raise capital. Preference shares meaning or Preference stock represents ownership in the company. The capital raised becomes a part of the Preference share capital. These shareholders enjoy preference over common shareholders on the assets and capital of the company. They receive dividends before equity shareholders. They also have a prior claim on the company’s assets compared to common shareholders.
What are the main types of Preference Shares?
1. Cumulative preference share
Cumulative preference shares entitle the shareholder to dividend payouts even when it is not making profits. As the name suggests, the company pays due dividends to the shareholders when it has earned profits. The payouts to preference shareholders must be made before the common shareholders receive payouts. Sometimes an additional payout is awarded to the holders of these preference shares.
2. Non – cumulative preference shares
These are the type of shares where the company can decide if the shareholders are to receive dividends and not receive omitted or pending dividends. The shareholders do not have a right to claim dividends. Profits are used to pay dividends.
3. Participating preference shares
In this case, the shareholders can demand a surplus on the dividend if the dividend paid out to the common shareholders is greater than the predetermined amount. If the company is liquidated the Participating preference shareholder can demand a share of the surplus profits thus gained.
4. Non-Participating preference share
The shareholders of these preference shares will only get pre-determined dividends. They will not get a share from surplus profits.
5. Redeemable preference shares
These shares can be redeemed by the company at a predetermined rate and time. These provide an antidote to inflation for the companies.
6. Non-redeemable preference shares
These preference shares cannot be redeemed by the company in its lifetime. They can be redeemed only when the company is closing down.
7. Convertible preference shares
These shares can be converted to equity shares by the shareholder after a certain period at a fixed rate.
8. Non-convertible preference shares
These shares that cannot be converted to equity shares are called non-convertible preference shares. They get fixed dividends when the company exists and preferential dividend payout when the company is dissolved.
Features of Preference Shares
1. Preference shares have a preferential right or claim over the company’s assets or capital.
2. The shareholders receive a fixed, pre-determined dividend from the company and have priority over equity dividends.
3. Preference shareholders are paid before equity shareholders when the company is winding up.
4. Preference shares can be redeemed from the company.
5. They can be converted to equity shares.
6. Some preference shares are eligible to receive cumulative arrears of dividends if any.
7. Preference shares can be invested for medium to long-term periods as the risk associated with them is low compared to equity shares.
The share market, especially equity shares, is infamous for being volatile. The finance world is filled with stories of people who invested in equity shares losing their hard-earned money. In many instances, they are deprived of their life savings. By choosing preference shares, many investors can rest assured that their money is safe. Not only is it protected from the volatility that equity experiences, but they are also assured of getting the investment in the worst case when the company dissolves.
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Frequently Asked Questions
The risk associated with Preference shares is low as the shareholders get a fixed dividend which is not the case with equity shareholders. Also, in case a company is liquidated, preference shareholders are the first to get their dues after the debts are paid.
Convertible preference shares can be converted to equity shares by following the correct procedure. The preference shareholder must fill out the required forms and inform the company one month before the Annual General Meeting.