Preference shares (also known as preferred stock) are a type of equity in a company that gives shareholders a fixed dividend, usually paid before common shareholders get any dividends. Unlike common shares, preference shares don’t have voting rights but offer more security because of their preference in getting dividends and assets in liquidation.
Content Outline
Key Takeaways for Preference Shares
Fixed Dividend Priority
Preference shareholders get dividends before common shareholders, more income stability.
No Voting Rights
In most cases, preference shareholders have no voting rights in company matters.
Higher Claim in Liquidation
Preference shareholders have a higher claim on company assets than common shareholders if the company is liquidated.
Hybrid Instrument
Preference shares have characteristics of both debt (fixed dividend) and equity (ownership in the company).
Convertible or Non-Convertible
Some preference shares can be converted into common stock, while others cannot.
Types of Preference Shares
1. Cumulative Preference Shares
Shareholders get dividends that were missed in previous periods. If company can’t pay dividends in a particular year, these dividends accumulate and are paid out when company becomes profitable again.
2. Non-Cumulative Preference Shares
Shareholders don’t have the right to claim unpaid dividends from previous years. If a company skips a dividend payment, it’s lost forever.
3. Participating Preference Shares
Shareholders get additional dividends beyond the fixed rate, often tied to company’s performance or excess profits.
4. Non-Participating Preference Shares
Shareholders get only their fixed dividend and have no claim to company’s additional profits beyond that amount.
5. Convertible Preference Shares
Shareholders can convert their preference shares into a fixed number of common shares after a certain period.
6. Redeemable Preference Shares
These shares can be bought back by the company at a future date or upon the occurrence of certain conditions, giving the company flexibility in managing its capital.
7. Irredeemable Preference Shares
These shares don’t have a maturity date and can’t be redeemed by the company, so shareholders get a perpetual stream of dividends.
Example
XYZ Corp issues 10,000 cumulative preference shares at $100 each with a 6% dividend rate. In a profitable year, each shareholder will get $6 per share annually. If XYZ Corp can’t pay dividends in a particular year, those dividends are carried forward to future years so shareholders will get paid when the company becomes profitable again.
Preference shares are an investment instrument that appeals to those who want fixed income and priority in dividend payments over common shareholders. With types like cumulative, non-cumulative and convertible, they offer many benefits, so it’s a hybrid of debt and equity financing.