Types of Preference shares: All you need to know

What do you mean by preference shares?

The meaning preference shares are those shares that are given importance over other equity shares. As per the Companies Act,2013, Indian companies issue two types of shares: equity shares and preference shares.

Investors are usually familiar with common stock which give voting rights and pays dividends. For example, when a company announces to pay dividends to its shareholders, they give first preference to pay dividends to preference shareholders, and then the remaining profit is divided as dividends among equity shareholders, and in any case, the company goes bankrupt or insolvent, the bondholders are given the first preference to get paid followed by preference shareholders and lastly equity shareholders to get paid from the liquidated money. 

Theoretically, both equity shareholders and preference shareholders are the owners of the company and can earn regular income. preference shares meaning is not as same as equity shares although both of them allow an investor to own a part of ownership in the company. Preference shares can only be owned by the Board of Directors, promoters of the company, and financial institutions.

What is preference share capital?

Preference share capital is the capital that is generated by a company through issuing preference stock. 

Features of preference shares

Preferred stocks can be good investment options for those who are looking for long-term investments and want to receive consistent returns. 

• Preference in dividends: Preferred stocks pay high dividends in comparison to common stocks in this current low-interest-rate environment and companies can pay dividends to equity shareholders only after paying preference shareholders. 
• Advance access to assets of the company: If the company goes bankrupt and insolvent, the preference shareholders are given first preference to get paid from the liquidated money. 
• No voting rights: Preference shareholders do not have any voting rights but sometimes they are allowed the right to vote only in case of extraordinary events. 
• Preferred stocks can be convertible: Preference shareholders can take advantage of converting their preference stocks into common shares and every company must be supposed to offer convertible shares 

Preference share types

There are nine types of preference share:

1. Cumulative preference shares: Cumulative preference shares are types of shares where shareholders are given the right to receive dividends for those years where dividends could not be paid due to insufficient profits. For instance, if a company does not make enough profit in a year, then it will not pay any dividends to its shareholders in that particular year but it pays cumulative dividends in the next year as arrears. 
2. Non-cumulative preference shares: Non-cumulative preference shares do not have the right to receive dividend payments for a year when the company does not have sufficient profits to pay dividends to its shareholders. So if a company does not pay dividend payments to its shareholders, the shareholders are not entitled to claim dividends in the coming year. 
3. Redeemable preference shares: Redeemable preference shares are those shares that can be redeemed by the issuing company to fulfill its purpose and they are redeemed within 20 days from the issue date. 
4. Non-redeemable preference shares: Non-redeemable preference shares are shares that cannot be redeemed by the company. The company can redeem shares only on shutting down of operation although Indian companies cannot issue irredeemable preference shares. 
5. Participating preference shares: Participating shares have the right to partake in the surplus profit of the company during liquidation after the company had paid to other shareholders. Participating preference shareholders have the right to receive dividends as well as have a share in the extra earnings of the company. 
6. Non-participating preference shares: Non-participating preference shares do not have the right to participate in the extra profit made by the company, however, non-participating preference shareholders are entitled to receive fixed dividends offered by the company. 
7. Convertible preference shares: Convertible shares allow shareholders to convert the convertible shares into equity shares but these shares can only be converted after a specified time as stated in the memorandum. 
8. Non-convertible shares: Non-convertible shares cannot be converted into equity shares of the company; however, they enjoy preferential rights when it comes to payment of capital in case of winding-up of the company. 

Difference between preference shares and equity shares

When you start your investment journey it is important to understand various investment options to have a smooth investment journey. Although equity shares and preference shares are similar but not the same. So, let's understand the difference between these two shares. 

• Equity shareholders have voting rights in the company however, preference shareholders are not entitled to voting rights in the company and as equity shareholders have voting rights, they take part in the company's management. 
• When a company distributes its dividends or payback capital during the liquidation of the company, preference shareholders enjoy first preference over equity shareholders. 
• The rate of dividend is fixed for preference shares while the rate of dividend fluctuates for equity shares with more earnings as the company is under no obligation to pay dividends to its equity shareholders. 
• Preference shares can be converted whenever a shareholder wishes to but equity shares can not be convertible. 
• Issuing preference shares is not compulsory for a company but a company must issue equity shares. 
• Preference shares represent the preferential rights to the company’s earnings and assets while equity shares represent owning a part of ownership in a company. 
• Preference shareholders are not entitled to receive any bonus against their holdings while equity shareholders are entitled to receive bonus shares against their holdings. 
• Preference shares are redeemable while equity shares are not redeemable. 
• Specific types of preference shareholders are qualified for arrears of dividends while equity shareholders do not get any arrears of dividends. 

Similarities between preference shares and equity shares

• Both equity and preference share own capital of the company. 
• Both equity and permanent shares are raised by public companies. 
• Both equity and preference shares come under section 85 of the Indian Companies Act 1956. 

To sum up, understanding different shares in the stock market is important for an investor to make informed decisions, and based on your investment goal and risk tolerance, individuals should decide on their investment avenues. Also, preference shares are considered a good investment option if you want to earn a respectable position in the company. 

Key takeaways:

• Preferred stocks are an asset class that comes between common stocks and bonds. 
• Individuals who want to earn consistent dividends can buy preference shares.
• Companies raise more capital by issuing preference shares. 
• Usually, companies issue preference shares to keep the debt to equity ratio lower.

Happy Investing!