Understanding Preference Shares: Meaning, Features and Types

Preference shares, also known as preferred stock, represent a unique form of equity ownership in a company. Unlike common shares, preference shares offer certain preferential rights and privileges to shareholders, such as priority in receiving dividends and assets in the event of liquidation. Preference shares are a popular investment choice for investors seeking steady income and downside protection, as they combine elements of both equity and debt securities. Understanding preference shares is essential for investors, businesses, and financial professionals to make informed investment decisions and understand the capital structure of a company. The difference between preference shares and equity shares is also vital.

Preference shares is one of the most asked topic to be studied for the commerce related exams such as the UGC-NET Commerce Examination.

In this article, the readers will be able to know about the preference shares along with other related topics in detail.

What are Preference Shares?

Preference shares, also known as preferred stocks, are a unique type of shares that offer shareholders the privilege to be paid dividends before the common equity shareholders.

As a preference shareholder, you enjoy the advantage of receiving dividends throughout the company's lifetime and also have the right to claim repayment of capital if the company ever has to close its operations.

Preference shares are often seen as a hybrid investment option because they exhibit traits of both equity and debt investments.

The funds gathered through the issuance of preference shares are termed as preference share capital. Preference shareholders are, in essence, owners of the company, but they are not entitled to voting rights like the common equity shareholders.

Key Characteristics of Preference Shares

Here are some of the primary features of preference shares:

• Preference shareholders are the first to receive dividends.
• Preference shareholders do not possess voting rights.
• Preference shareholders can claim the company's assets in case of liquidation.
• The dividend payout for preference shareholders is fixed, regardless of the company's profit margin.
• Preference shares serve as a source of hybrid financing.

Different Types of Preference Shares

Here's a look at the various types of preference shares:

• Cumulative preference shares: Cumulative preference shares allow shareholders to accumulate dividends during non-profitable years. These dividends are then paid out in a lump sum when the company starts making profits again.
• Non-cumulative preference shares: Non-cumulative preference shares do not offer the benefit of accumulating dividends. If the company doesn't make a profit in a given year, no dividends are paid out for that year, and shareholders cannot claim dividends in future profitable years.
• Participating preference shares: Shareholders with participating preference shares can claim a portion of the company's surplus profit (after other shareholders have been paid their dividends) when the company is liquidated. These shareholders enjoy both fixed dividends and a share of the surplus profit.
• Non-participating preference shares: Non-participating preference shareholders are only entitled to a fixed dividend. They do not have the right to any surplus profits.
• Redeemable Preference Shares: Redeemable preference shares can be bought back or redeemed by the issuing company at a predetermined rate and date. They provide a safety net for the company during inflationary periods.
• Non-redeemable Preference Shares: Non-redeemable preference shares cannot be redeemed until the company is being wound up.
• Convertible Preference Shares: Convertible preference shares give shareholders the option to convert their preference shares into equity shares at a fixed rate after a certain period, as mentioned in the memorandum.
• Non-convertible Preference Shares: Non-convertible preference shares cannot be converted into equity shares. Shareholders with these shares receive a fixed dividend payout and have the right to claim dividends before others during the company's dissolution.

Conclusion

Preference shares represent a unique form of equity ownership that offers certain preferential rights and privileges to shareholders. They provide investors with a steady income stream through fixed dividends and downside protection through priority in dividend payments and asset distribution in the event of liquidation. Understanding preference shares is important for investors looking to diversify their investment portfolios, businesses considering different sources of capital, and financial professionals analyzing the capital structure of companies. By understanding the characteristics and features of preference shares, investors can make informed investment decisions and effectively manage their investment portfolios. Equity and preference share is very interesting to be studied.

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