Preference Shares: Meaning, Types & Features

Preference Shares: Meaning, Types & Features – A Guide by Battlecraft Money Solutions Pvt. Ltd.

The world of investing offers a diverse range of instruments, each catering to specific investor goals and risk appetites. Preference shares, also known as preferred stock, occupy a unique space within this landscape. This guide by Battlecraft Money Solutions Pvt. Ltd. delves into the intricacies of preference shares, exploring their meaning, different types, and key features.  

Understanding Preference Shares

Imagine a company raising capital through two types of shares: common shares and preference shares. While both represent ownership in the company, preference shares offer certain advantages over common shares. They prioritize the shareholder in two key aspects:  

• Dividends: Holders of preference shares receive dividends before any dividends are paid to holders of common shares. These dividends are typically fixed, offering a predictable source of income.  
• Liquidation: In the event of company liquidation, preference shareholders have a prior claim on the company’s assets compared to common shareholders. This means they are more likely to recoup their investment after creditors are paid.  

Why Choose Preference Shares?

Several factors make preference shares an attractive investment option for some individuals:

• Fixed Income: Preference shares provide a steady stream of income in the form of dividends, making them suitable for investors seeking predictable returns.  
• Lower Risk: Compared to common shares, preference shares offer a degree of protection. The fixed dividend and priority claim on assets mitigate some of the volatility associated with common stock.  
• Hybrid Investment: Preference shares offer characteristics of both stocks and bonds. They provide ownership rights like stocks but deliver fixed income like bonds.  

Types of Preference Shares

The world of preference shares is not monolithic. Companies can issue various types, each with its own set of features. Let’s explore some of the most common ones:  

• Cumulative Preference Shares: These shares offer a safeguard against missed dividend payments. If a company withholds dividends in a particular year, the arrears (unpaid dividends) accumulate. When the company resumes dividend payments, preference shareholders receive both the current year’s dividend and the accumulated arrears before any dividends are paid to common shareholders.  
• Non-Cumulative Preference Shares: In contrast to cumulative shares, missed dividends on non-cumulative preference shares are simply lost. They do not accumulate for future payment.  
• Participating Preference Shares: These shares offer a combination of fixed dividends and the potential for additional returns based on the company’s performance. After the company fulfills its obligation to pay the fixed dividend, participating preference shareholders may be entitled to share in any remaining profits distributed to common shareholders.  
• Convertible Preference Shares: These shares provide investors with the flexibility to convert their holdings into common shares at a predetermined price and within a specific timeframe. This allows them to benefit from potential capital appreciation associated with common stock if the company’s performance improves.  
• Redeemable Preference Shares: These shares give the issuing company the option to repurchase them from investors at a predetermined price and date. This flexibility allows the company to manage its capital structure in the future. Conversely, non-redeemable preference shares cannot be redeemed by the company.  
• Puttable Preference Shares: These shares grant investors the right, but not the obligation, to sell their shares back to the company on a specific date or within a predefined timeframe. This feature provides investors with an exit strategy if they no longer wish to hold the shares.  

Features of Preference Shares

Beyond the classification into types, preference shares possess certain key features:

• Fixed Dividend: As mentioned earlier, preference shares offer a predetermined dividend rate. However, it’s important to remember that this rate is fixed at the time of issuance and may not be adjusted for inflation.  
• Voting Rights: Preference shareholders generally have limited or no voting rights on company matters like board elections or major business decisions. This stands in contrast to common shareholders who typically have voting rights.  
• Liquidity: Compared to common shares, preference shares can be less liquid, meaning they may be harder to buy and sell quickly. This is because they represent a smaller portion of the company’s ownership and may attract a narrower investor base.  
• Call Provisions: Some preference shares may be subject to call provisions. This means the company can redeem the shares from investors after a certain period at a predetermined price.