Preference shares: What are they and are they different from equity shares?

Preference shares, as the name indicates, are given preference over equity shares. The preference given here is reflected at the time of payment of dividend to shareholders. These shares are often called preferred stocks. Preference shareholders get preference for payment during a company’s liquidation as well. Often preference shares have a pre-determined amount of dividend attached to them. However, preference shareholders don’t hold voting rights in the company. Thus, these shares are a great tool to boost capital without diluting the voting rights in a company.

Different types of preference shares

There are several different types of preference shares that may be issued by companies. These are:

Cumulative preference shares: Cumulative preference shares are a unique type of preferred stock that entitle the preference shareholder to cumulative dividend in case the company doesn’t make a profit in a year or for a few years. These unpaid dividends accumulate over time and must be paid back in toto when the company generates profits in the succeeding year.

Non-cumulative preference shares: As the name suggests, non-cumulative shares are the opposite of cumulative shares. Here, the dividend doesn’t accumulate over the unpaid years. Thus, if a company doesn’t make profit in a particular year and the shareholders are not paid, they are not entitled to claim these dividends in the future.

Redeemable preference shares: Redeemable preference shares can be recalled or repurchased by the company at a fixed rate and date. These types of preference shares are of great comfort to the company during times of inflation.

Irredeemable preference shares: Irredeemable preference shares can’t be redeemed by a company during its lifetime. These types of preference shares are redeemed only at the time of winding up of a company.

Participating preference shares: These types of preference shares entitle their holders to a part of the surplus profit when the company is liquidated, dividends to other shareholders are paid and a higher dividend paid if the company earns more than its annual benchmark.

Non-participating preference shares: Non-participating shares don’t empower their holders to additional earnings from surplus profits of the company. They function true to the definition of a preference share; they receive only a fixed dividend.

Convertible preference shares: These preference shares entitle their holders to ‘convert’ their preference shareholding to equity shares at a fixed rate. This conversion can be processed at the expiry of a stipulated period mentioned in the Memorandum of Association. These are preferred due to their versatility.

Non-convertible preference shares: Non-convertible preference shares can’t be converted into equity shares unlike convertible shares. They function as mundane preference shares throughout the lifetime of the company.

Adjustable-rate preference share: These types of preference shares have no predetermined rate or dividend. The amount of dividend depends on the existing rates in the market at all times.

In Conclusion

All these different types of preferences shares come with their own set of risks and merits that vary in importance based on the needs of the shareholder. Proper study of the company’s growth and performance can help you make the best decision regarding purchase of these investment instruments.