Corporate Practice bd
What are preferred shares? Different Types,With-Practical Examples
Preference shares, also known as preferred stock, are a class of shares in a company that typically have certain rights and privileges over common shares (ordinary shares). These rights and privileges are designed to attract investors who desire a steady income stream and more security compared to common shareholders. Here are the key characteristics and features of preference shares:
Characteristics of Preference Shares:
Fixed Dividend:
Preference shareholders receive a fixed rate of dividend, which is specified when the shares are issued. This dividend is paid out before any dividend is paid to common shareholders.
Preference in Dividend Payments:
In case of dividend distribution, preference shareholders are entitled to receive dividends before common shareholders. If the company cannot pay dividends in a particular year, the unpaid dividends may accumulate (cumulative preference shares) or be forfeited (non-cumulative preference shares), depending on the type of preference shares issued.
Priority in Liquidation:
In the event of liquidation or winding up of the company, preference shareholders have a higher claim on the company's assets compared to common shareholders. They receive their capital back before common shareholders, but after creditors and bondholders.
No Voting Rights:
Generally, preference shareholders do not have voting rights in the company's affairs, except in special circumstances or as specified in the terms of the shares.
Convertible or Non-Convertible:
Preference shares can be either convertible or non-convertible. Convertible preference shares give the shareholder the option to convert their preference shares into a specified number of ordinary shares after a predetermined period or under certain conditions.
Redeemable or Irredeemable:
Some preference shares may be redeemable, meaning the company can buy them back after a specified period, often at the discretion of the company. Irredeemable preference shares, on the other hand, do not have a maturity date and are treated as permanent capital.
Advantages of Preference Shares:
Stable Income:
Preference shareholders receive a fixed dividend, providing a stable income stream that is attractive to income-oriented investors.
Priority in Liquidation:
Preference shareholders have a higher claim on company assets in case of liquidation, which enhances their security compared to common shareholders.
Flexibility for Issuing Companies:
Issuing preference shares allows companies to raise funds without diluting voting control, as preference shareholders typically do not have voting rights.
Disadvantages of Preference Shares:
Limited Voting Rights:
Preference shareholders usually do not have voting rights, which may limit their influence on company decisions.
Fixed Dividend Obligation:
Companies are obligated to pay the fixed dividend to preference shareholders, which can be a burden during periods of financial difficulty.
Higher Cost:
The fixed dividend rate on preference shares may be higher than the cost of debt financing, making them a relatively expensive form of capital for the company.
Preference shares are commonly used by companies to raise capital while providing investors with a relatively secure investment option. They play a crucial role in the capital structure of many corporations, offering a balance between the stability of debt and the flexibility of equity financing.
Types of Preference Shares with Examples
Preference shares, also known as preferred stock, are a class of shares that provide certain privileges over common shares. These privileges typically include preferential dividends and priority in asset distribution upon liquidation. Here are the main types of preference shares along with examples:
1.Cumulative Preference Shares
Definition:
Cumulative preference shares ensure that if a company does not pay dividends in any given year, the unpaid dividends accumulate and must be paid out before any dividends are paid to common shareholders.
Example:
ABC Ltd. issues cumulative preference shares with a dividend rate of 8%. In year 1, ABC Ltd. does not pay any dividends. In year 2, before paying dividends to common shareholders, ABC Ltd. must pay the 8% dividend for both year 1 and year 2.
2.Non-Cumulative Preference Shares
Definition:
Non-cumulative preference shares do not have the right to claim unpaid dividends from previous years. If the company does not declare dividends in a particular year, shareholders cannot claim it in the future.
Example:
XYZ Corp. issues non-cumulative preference shares with a 7% dividend rate. In year 1, XYZ Corp. does not pay any dividends. Shareholders will not be entitled to receive the missed dividend from year 1 in subsequent years.
3.Participating Preference Shares
Definition:
Participating preference shares give shareholders the right to receive a specified dividend and an additional dividend based on certain conditions, such as if common shareholders receive a dividend above a specified amount.
Example:
DEF Inc. issues participating preference shares with a 6% fixed dividend and a provision that allows shareholders to receive an additional dividend if common shareholders receive more than a 10% dividend. If common shareholders get a 12% dividend, participating preference shareholders will receive their 6% plus a portion of the additional 2%.
4.Non-Participating Preference Shares
Definition:
Non-participating preference shares only provide the fixed dividend and do not entitle shareholders to any additional dividends beyond the fixed rate, regardless of the company's profits.
Example:
GHI Ltd. issues non-participating preference shares with a 5% fixed dividend. Even if common shareholders receive a 15% dividend, preference shareholders will only receive their fixed 5%.
5.Convertible Preference Shares
Definition:
Convertible preference shares allow shareholders to convert their preference shares into a predetermined number of common shares after a specific period or upon the occurrence of certain events.
Example:
JKL Co. issues convertible preference shares with a 4% dividend rate, convertible into common shares at a ratio of 1:5 after 5 years. After 5 years, if the common shares have appreciated significantly, preference shareholders may convert their shares to benefit from the higher value.
6.Non-Convertible Preference Shares
Definition:
Non-convertible preference shares cannot be converted into common shares. Shareholders will only receive the fixed dividend and other preferential rights.
Example:
MNO Inc. issues non-convertible preference shares with a 6% fixed dividend. Shareholders will continue to receive their fixed dividend and cannot convert their shares into common shares.
7.Redeemable Preference Shares
Definition:
Redeemable preference shares can be bought back (redeemed) by the issuing company after a certain period or upon the occurrence of specific conditions.
Example:
PQR Ltd. issues redeemable preference shares with a 5% dividend rate, redeemable after 7 years at par value. After 7 years, the company has the option to buy back the shares from the shareholders.
8.Non-Redeemable Preference Shares
Definition:
Non-redeemable preference shares cannot be bought back by the issuing company and exist in perpetuity unless the company is liquidated.
Example:
STU Corp. issues non-redeemable preference shares with a 6% fixed dividend. These shares will continue to provide dividends indefinitely and cannot be redeemed by the company.
Conclusion:
Preference shares offer a variety of structures to meet different investment needs, balancing risk and return preferences for both the issuing company and investors. The type of preference share chosen by a company will depend on its specific financial strategy and the preferences of its investors.