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Types of Preference Shares

IndianMoney.com Research Team | Posted On Friday, August 03,2018, 07:38 PM

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Types of Preference Shares

 

 

 

Preference shares are shares having preferential rights with respect to dividend payments. However, these shares do not confer upon the shareholder any ownership rights. Dividends to preference shareholders are paid, before equity shareholders get paid. Usually, preference shares have a fixed rate of dividend.

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Types of Preference Shares

 

Preference shares are issued to raise funds without diluting voting rights. These shares are considered to be a hybrid instrument because they carry certain characteristics of debentures like assured returns.

Preference shares are usually issued to:

 

  • Promoters of company
  • Management
  • Institutional lenders

 

The prices of ordinary or equity shares fluctuate, depending on supply and demand. Unlike equity shares, preference shares are not traded on the stock exchange. These are illiquid assets and their prices do not fluctuate like those of equity shares. Preference shares appear in the company's balance sheet under the head 'capital'.

 

Memorandum of Association and Articles of Association:

 

The rights of preference shares must be mentioned in the Memorandum of Association and Articles of Association.

 

  • Preference shareholders cannot claim any other rights apart from those expressly mentioned in the MOA or AOA.
  • Companies cannot allot preference shares if they are not mentioned in the MOA or AOA of the company.

 

Why do companies issue preference shares?

 

  • Issuing equity shares would mean diluting ownership rights. Therefore, to safeguard ownership rights, companies issues preference shares.
  • Companies issue preference shares because they wouldn’t want to avail loans.
  • Companies issue preference shares because they give maximum flexibility, without the fear of missing interest payments. In case companies issue bonds, a missed interest payment puts the company at risk of defaulting on an issue. This results in forced bankruptcy.

 

Why do investors like preference shares?

 

  • Investors like to invest in preference shares because these shares enjoy preference over equity shares, vis-a-vis dividends.
  • Investors like banks and institutional investors like to invest in preference shares because they want to avoid the risk of fluctuating equity share prices.
  • Preference shares are a combination of equity shares and bonds. Therefore, these are relatively stable.
  • Shareholders prefer to invest in preference shares because it offers consistent dividend payments minus lengthy maturity dates like bonds.
  • Preference shares are less risky when compared to equity shares.

 

SEE ALSO: Types Of Investment Plans

 

Features of Preference Shares:

 

Preference shares have the following features:

 

1. Preference shareholders do not have any voting rights.

2. Preference shareholders enjoy preferential rights over dividends. These earn a fixed rate of dividend.

3. Preference shares bear some characteristics of debentures. Hence, they are called hybrid security.

4. Generally, preference share dividend is higher than debenture interest.

5. These shares have a preferential right for repayment of capital in case of liquidation.

6. Preference shares are not traded on the stock exchange.

 

Types of Preference Shares:

 

Following are the types of preference shares:

 

1. Cumulative preference shares:

 

Shareholders holding cumulative preference shares have the right to receive the arrears of dividend before any dividend is paid to equity shareholders. Unless mentioned, preference shares are presumed to be cumulative.Let’s say dividends on preference shares for the year 2015 and 2016 have not been paid. Before paying the dividend to equity shareholders for the year 2017, the directors must pay the preference dividends for the year 2015, 2016 and 2017 and only then can dividends be paid to equity shareholders for the year 2017.

 

2. Non-cumulative preference shares:

 

Unlike cumulative preference shares, dividends on non-cumulative preference shares are only payable out of the net profits. Such shareholders cannot claim arrears in dividend. If dividends are not paid by the company during a particular year, they lapse.

 

3. Participating preference shares:

 

Participating preference shareholders are entitled to participate in the balance of profits of the company with equity shareholders after they receive a fixed rate of dividend on their shares. In addition to this, participating preference shares may also have the right to share in the surplus assets of the company on liquidation.

 

4. Non-participating preference shares:

 

Unlike participating preference shares, non-participating preference shares are not entitled to participate in surplus profits. They are only entitled to a fixed rate of dividend. Unless mentioned, all preference shares are non-participating.

 

5. Convertible preference shares:

 

Convertible preference shares can be converted into equity shares within a certain period.

 

6. Non-convertible preference shares:

 

Non-convertible preference shares cannot be converted into equity shares.

 

7. Redeemable preference shares:

 

If authorized by the articles, a company limited by shares may be authorized to issue redeemable preference shares. These shares are usually redeemable after a fixed period.

 

8. Guaranteed preference shares:

 

Guaranteed preference shareholders have the right to receive a fixed dividend even if the company makes insufficient profits or incurs loss.

 

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