What are Preference Shares & How to Buy: Meaning, Types, Redemption, & Features

What are Preference Shares & How to Buy: Meaning, Types, Redemption, & Features

Preference Shares

In this article we will discuss everything related to preference shares. We will start with preference shares meaning and features. Then we will go on to discuss the types of preferences shared. Further we will talk about why you should invest in preference shares and the risk associated with preference shares. Let’s begin!

What Are Preference Shares?

As their name suggests, preference shares are those the firm prioritizes over others when paying out dividends. It implies that the shareholders will be paid first if the business has financial success and declares dividends or preferred shares. The corporation won't start paying dividends to other shareholders until preference owners receive their payouts. Additionally, preference shareholders get paid before other types of shareholders if the company goes through the liquidation process. However, holders of preference shares are not allowed to vote and are not involved in the company's internal decision-making.

Features Of Preference Shares?

The following features of preference shares make them differ from common equity or debt -

  1. Owners of preferred shares have a rare opportunity to receive dividend payments before later-purchasing investors may or may not. Whether or not the dividends are fixed depends on the benchmark interest rate.
  2. A shareholder with a preference share is eligible to receive dividend payments first, or on priority, before other investors, as previously said.
  3. Another characteristic of these securities is callability, which is the potential right of the issuer to call or repurchase preference shares at some point in the near future. One can reissue their preference share at a specific date that the company specifies, similar to becoming converted.
  4. Preference shares give their holders priority over non-preferential stockholders in collecting the company's assets in the event of a company's dissolution.
  5. If one's holdings need to be altered, they are commonly converted into a predetermined amount of non-preference stocks. Common stock may also be converted from preference shares. Investors are informed that while some preference shares may be converted at any time after a specific date, other shares may need the board of directors' consent.
  6. Preference Shareholders may, under extreme circumstances, be permitted to vote. Typically, purchasing stock in a corporation does not entitle you to vote on how the firm is run.

Different Types Of Preference Shares? 

The preference shares types that you should know of are discussed below:

  1. Cumulative preference share: Cumulative preference shares are essentially regular preference shares with a bonus. The additional benefit in this situation is that even if the issuing firm has historically failed to pay dividends, the holders of these shares still have the right to do so.
  2. Non-cumulative preference shares: Dividends are not accumulated on these shares. Therefore, shareholders cannot claim future revenues to pay back outstanding dividends if a company experiences a loss in a specific year, mainly because the current year's net gains are used to pay non-cumulative preference stockholders.
  3. Participating preference shares: If the company is liquidated after dividends have been distributed to the other shareholders, these shares entitle the stockholders the right to a portion of the surplus profits. In other words, these stockholders have the same rights to dividend payments as equity owners and share in the company's excess profit.
  4. Non-participating preference shares: Non-participating preference shareholders, as the name implies, do not receive a portion of any surplus assets or earnings following a company's dissolution. Only the pre-fixed dividends are available to shareholders of this sort of share.
  5. Redeemable Preference Shares: Redeemable preference shares are those that the issuing corporation can buy back or redeem at a set price and time. These shares help the business by acting as a safety net during inflation.
  6. Non-redeemable Preference Shares: Preference shares that cannot be redeemed during the firm's existence are known as non-redeemable shares. These shares can thus only be redeemed when the company is shutting down.
  7. Convertible Preference Shares: These shares are corporate fixed-income instruments. The investor may convert them into a particular number of shares of the company's common stock later or after a specified time.
  8. Non-convertible Preference Shares: Preference shares that cannot be converted into equity shares are known as non-convertible preference shares. These shares will only receive fixed dividend payments, and they will receive dividend payments in priority in the case of a company's liquidation.
  9. Adjustable Preference Shares: variable rate A particular class of preferred stock pays a dividend that is affected by variations in a benchmark rate. Dividend adjustments typically take place once every three months.

Why Should You Consider Investing In Preference Shares?

Preference stock benefits both the issuer and the stockholder, allowing investors first dibs on dividends. Both of these categories can reap certain advantages.

Here are the advantages that are granted to the issuer:

There is no dividend requirement. Hence, the issuer can delay dividend payments when using cumulative preferred shares. The firm may defer payments to investors until the next month if there are not enough dividend funds.

It offers flexibility. The board of directors and management of the company value their ability to customize the terms of the shares by using preferred stock.

While on the other hand, the benefits that the shareholder gets are-

Secured place. In the event of the company's bankruptcy, preferred shareholders are considerably safer than common shareholders. The advantages of first claiming a company's assets belong to the former.

It can serve as a means of additional fixed income. Depending on the type of preference share they have chosen and the firm in which they have purchased ownership, investors may receive a fixed extra income from preference stock in the form of dividend payouts.

Risks Associated With These Shares?

The inherent risks associated with these shares are similar to those associated with all other financial products. When there are significant market movements, there are concerns about the dividend payout amounts of the shares. Therefore, those with a slightly lower risk tolerance would not want to take too many chances with this particular investment opportunity.

Additionally, some PAT-linked preference share types might initially promise higher returns. But there can be severe risks connected with the same.

Lastly, companies with significant market capitalizations that can sustainably pay out sizable dividends to a sizable subscriber base generally issue these shares. While it might seem like a risk-reduction strategy, it might or might not be effective.