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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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:
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'.
The rights of preference shares must be mentioned in the Memorandum of Association and Articles of Association.
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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.
Following are the types of 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.
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.
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.
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.
Convertible preference shares can be converted into equity shares within a certain period.
Non-convertible preference shares cannot be converted into equity 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.
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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