Preference shareholders enjoy preferential treatment when it comes to sharing company profits. As a result, they are a good option for investors who seek regular dividends. These shares appeal to a wide range of investors due to their sheer variety and alternatives. However, they are not as popular as equity shares. This article covers features and types of preference shares in detail.
Preference shares or preferred stock represent ownership in a company. Preference shareholders enjoy the preference over common shareholders on the assets and earnings. Also, in case of bankruptcy, preferred shareholders enjoy the priority to receive the company’s assets before common shareholders.
A company issues preference shares to raise capital. This becomes part of the preference share capital. Preference shareholders receive dividends before the equity shareholders. A specific type of preference share is eligible to receive arrears of dividends. Furthermore, you can easily convert these shares to equity shares.
Also, in India, you can redeem preferred shares within 20 years of their issuance. Such share is redeemable preference shares. On the other hand, the Companies Act 2013 doesn’t allow companies to issue irredeemable preference stocks in India.
Though preference shareholders have the right to company earnings first, they do not have voting rights like the equity shareholders.
Many long-term investors seeking regular income prefer these shares, as the dividends are higher than what an equity shareholder gets.
Following are the different types of preference stocks:
Convertible Preference Shares
Convertible preference shareholders can convert their preferred stocks to common stocks. Investors who wish to get preferred dividends, as well as benefit from a rise in the common share price, choose these shares. As a result, there are two advantages: guaranteed earnings through preferred dividends and the potential to earn higher returns as the common stock price rises. As per the memorandum, this conversion can take place within a particular time frame.
Non-Convertible Preference Shares
Non-convertible preference shareholders have no such right to convert to equity stocks.
Redeemable Preference Shares
Redeemable shares give the company the right to buy back the share from the shareholders on a set date or by giving prior notice. The company can buy back the share for its own use. The price of such repurchase is prefixed.
Irredeemable Preference Shares
The company can only redeem irredeemable shares during liquidation or when it winds up its operations.
Participating Preference Shares
Participating preference shareholders receive an additional dividend other than the preference dividend. In other words, the company pays an extra dividend to the participating shareholders. The additional rate is usually fixed. Furthermore, these shareholders have rights over the company’s surplus assets when it is winding down or liquidating.
Non-Participating Preference Shares
Non-participating preference shareholders only enjoy dividends at a fixed rate and are not eligible for surplus profits. The common stockholders enjoy the additional profits.
Cumulative Preference Shares
Cumulative shares permit investors to receive dividends in arrears. In other words, sometimes, a company’s financial position prevents it from paying dividends to its stockholders. Dividends cannot be paid to common shareholders unless preference stockholders are paid. Under such circumstances, the corporation decides to pay cumulative dividends the following year. The cumulative preferred stockholders are sometimes granted interest earned by stockholders on arrear dividends.
Non-Cumulative Preference Shares
Non-cumulative preference shareholders are not eligible to receive dividends in arrears. They are only eligible for dividends from the current year’s profit. In other words, if a company doesn’t make profits or decides not to pay dividends in a year, these shareholders cannot claim unpaid dividends in the future. So, the shareholders will not receive any dividend for that year.
Preference Share with a Callable Option
The company that issues callable option shares has the right to call in or buy back the stocks at a specific price on a certain date. The prospectus specifies the call price, the date after which the shares can be called, as well as the call premium.
Adjustable Preference Shares
For adjustable preference shareholders, the dividend rates are dynamic. The rate depends on the prevailing interest rates in the market. Hence, the dividend rates are volatile.
Following are the key features:
- Preference: As the name suggests, preference shareholders enjoy preference over common shareholders. They have a priority to receive dividends from the company.
- Voting Rights: Preference shareholders do not have voting rights, like equity shareholders.
- Dividends Pay-outs: Preference shareholders receive dividends on specific dates.
- Conversion: You can easily convert these shares to equity shares. Some shares can be converted to common stock after a specific date. While some types of shares require prior approvals and permissions form the board of directors to convert.
- Liquidation: When a company declares bankruptcy or liquidates, preference shareholders have the right over the company’s assets.
- Callability: The company can repurchase the preferred stock on specified dates.