Preference Share Meaning
Preference shares, also known as preferred stock, the preference shares are the type of shares whose shareholders are given preference compared to the other common stockholders when it is time to pay dividends.
Similarly, when it is time to share profits derived from the financial year, those who own preferred shares are given the returns first, and the dividends handed out are fix in nature.
The returns from these types of shares are exponentially more than the other commonly given out shares.
Preference Shares Features
Preference shares are endowed with a lot of features. Simultaneously, some of the parts for only a few preferred shares, the rest of the features are common for all varieties of preference shares. Some of them include:
- Maturity: In terms of maturity, the preference shares have an outcome similar to equity shares. The preference shares are not redeemable, and the company is not liable to pay the equivalent amount as long as the company is running. Only when the company is on the verge of closure will the company pay the preference shareholders after the management has mutually decided.
- The income claims : A fixed rate of dividend paid to the preferred stockholders. The management decides that the individuals who own preference shares have the right to claim compensation before it was given to the owners of equity shares. The ultimate decision to invest the dividend or pay it in the form of a bonus rests with the company.
- Claims on assets: When the company is about to shut down, the funds’ repayment is first made to the individuals who own preference shares than the shareholders of the equity shares. But the preference shareholders do not have any legitimate claim on the surplus assets of the business entity.
- Control: Because the owners of preference shares do not have any legal say during voting, they are not considered to have a say in the company’s decisions. However, in the rare case when their dues have been left unpaid even after repeated reminders, the preference shareholders can vote on the resolution that can put forward for addressing their grievances.
- The hybrid form of security: The preference shares have features of both equity shares and other forms of debt financing. Hence they are known as hybrid forms of protection.
Preference shares are similar to equity shares because the payment of funds is not mandatory. The dividend paid is only from the percentage of distributable profits, and the dividend paid is not considered an expense while calculating the business’s tax liability.
Types of preference shares
Cumulative preference shares
The owners of preference shares have the legal right to put forward their claim returns for even the financial years that have not recorded any profits. When the company does make substantial profits, the cumulative preference shareholders are given the dividend by computing for all the years to date. The dividend has not been paid.
Non-cumulative preference shares
The individuals who are shareholders of the non-cumulative preferred shares types have no right to demand the previous years’ returns. They are given out dividends only in the financial year where profits have been recorded.
Redeemable preference shares
The main rule that governs holding the shares is that the company needs not to pay a dividend until the company is on the verge of liquidation. The company can redeem the shares that come under the category of redeemable preference shares, and they should be fully paid off either out of the profits or from the freshly invested funds.
Irredeemable preference shares
Irredeemable preference shares refer to those shares that can be redeemed only when the company is on the verge of closure.
Participating preference shares
The owners who have a stake in the participating preference shares have a right to get dividends when there are sustainable profits. Firstly, a dividend at a fixed rate is issued to them. After that the rate of returns is equal to that of the equity shares.
Non-participating preference shares
Non-participating preference shares are eligible to get only a fixed rate of returns, and they do not have a right to the company’s extra profits.
Convertible preference shares
After a predetermined period, the convertible preference shares owners can change their shares into holdings in equity shares.
Non-convertible preference shares
The preference shares that cannot convert into equity shares are termed as non-convertible preference shares.
Advantages of preference shares
- The company is not legally bound rights to pay returns in the case of preference shares until the company filed liquidation, by the mutual decision of the company’s management, the amounts paid as the dividend, and it paid from the profits obtained.
- Preference shares are a source of funds for the company in the long run.
- The company is not responsible for redeeming the shares that come under the category of preference shares until the company is in operation.
- When the share of the sustainable profits increases, the amount of dividends doled out to the preference share stakeholders also varies.
- The owners of the preference shares do not have any voting rights in managerial decisions.
Disadvantages of preference shares
- The preference shares are more costly than other types of shares declared by the company as the expectation of the preference shareholder is more than other shares owners.
- The rate of returns on the preference shares is lesser than the different types of shares, such as equity shares.
- Preference shares are considered riskier compared to additional shares as they are subject to fluctuations in the market.
- Preference shareholders do not have any rights to vote or take part in the company’s decision-making process.
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