What are preference Shares?
Preference shares, also known as preferred shares, are a class of shares issued by a company that combines features of both equity and debt. Holders of preference shares are entitled to certain preferential rights and benefits compared to common equity shareholders, but they do not have the same voting rights or ownership stake. In India, preference shares are a common form of capital raising for companies.
Features of Preference Shares
Dividend Preference: One of the primary features of preference shares is the preference for dividend payments. Holders of preference shares receive a fixed dividend rate, which is often higher than what common shareholders receive. This fixed dividend must be paid before any dividends are distributed to common shareholders.
Limited Voting Rights: Unlike common shareholders, preference shareholders usually have limited or no voting rights. They might only have a vote in matters that directly affect their rights or the company's stability, such as changes to the rights attached to preference shares or winding up of the company.
Redemption: Many preference shares come with a redemption feature, allowing the company to buy back the shares after a specified period or under certain conditions. This can provide flexibility for the company in managing its capital structure.
Cumulative or Non-cumulative: Preference shares can be cumulative or non-cumulative. Cumulative preference shares ensure that any unpaid dividends accumulate and must be paid in the future, whereas non-cumulative preference shares do not carry forward unpaid dividends.
Convertible: Some preference shares are convertible, meaning they can be exchanged for common equity shares after a specified period or under certain conditions. This feature can be attractive to investors seeking the potential for capital appreciation.
Types of Preference Shares
Cumulative Preference Shares: These shares entitle shareholders to receive any unpaid dividends in future years, in case the company is unable to pay dividends in a particular year.
Non-Cumulative Preference Shares: These shares do not allow the accumulation of unpaid dividends. If the company cannot pay dividends in a given year, the shareholders have no claim on these unpaid dividends in the future.
Participating Preference Shares: Participating preference shareholders not only receive their fixed dividend but also have the right to participate in the surplus profits, typically alongside common shareholders, after all obligations have been met.
Non-participating Preference Shares: Non-participating preference shareholders only receive their fixed dividend and do not have a right to share in the surplus profits.
Preference Shares Advantages
Steady Income: Preference shareholders receive a fixed dividend, which provides them with a steady source of income. This is especially attractive to investors seeking regular income.
Priority in Dividends: In case of financial difficulties or during dividend distribution, preference shareholders have a higher claim on the company's earnings compared to common shareholders.
Safety and Stability: Preference shares are considered less risky than common equity because of the fixed dividend and the preference they enjoy during dividend payments.
Convertible Option: Convertible preference shares provide an opportunity for capital appreciation if the company's common shares perform well.
Diversification: For investors, preference shares offer a way to diversify their portfolio, as they combine characteristics of both equity and debt investments.
In conclusion, preference shares are a financial instrument in India that allows companies to raise capital while offering investors a degree of safety and a fixed income. Their features, types, and advantages make them a valuable tool for both companies and investors in the Indian financial market.