Types of Preference Shares in Stock Market

A company generally issues two types of shares: Common Shares and Preference Shares. When companies bring IPO, they raise money by issuing common shares, and shareholders holding common shares are known as common/equity shareholders. Sometimes companies issue special shares to preferred individuals, these individuals are called preferred shareholders.

 

 

What is Preference Share

Preference shares means those shares that give the right of preference to individuals over equity shareholders concerning dividends or the company’s assets in case the situation of liquidation arises.

 

Preference shareholders are generally Big Investors like Rakesh Jhunjhunwala, and other top Big Bull of India stock market, or Mutual Funds, or Big Financial Institutions because such shares are issued by the company when they require a large number of funds in less time.

 

Preference shareholders cannot sell the shares in the stock market as such shares cannot be traded whereas common shares can be sold easily in the stock market. Preference shares come with a maturity period and shareholders get dividends during the life-cycle of those shares, upon maturity, preference shareholders get their principal amount back.

 

 

Methods of selling preference shares

Preference shares can be sold only by following these two methods:

1. Call Feature: By this method, the issuing company can call back their preference shares i.e. they can buy their shares from existing shareholders at a pre-decided price.
2. Convertible Feature: In this method, preference shares can be converted into common shares after a fixed period.

 

 

Features of Preference Shares

1). Fixed-rate of Dividend: Preference shareholders get a fixed rate of dividend before paying dividends to equity shareholders. Whether the shareholders will get dividends each year depends on the nature of preference shares.

Preference shares can be a good source of fixed income in form of dividends as preference shareholders get a preference over common shareholders. Know how to generate passive income from dividends in detail:

2). No Security: Companies do not offer any security against preference shares. The preference share capital is a part of the owner’s fund capital. It means no collateral is taken or given by the company.

3). Voting Rights: The preference shareholders do not get any voting rights under general conditions. However, preference shareholders get voting rights if the dividends are not paid for two years or more.

4). Hybrid Security: Preference shares are called hybrid securities, as these shares have the features of equity shares as well as debentures.

 

You also need to know the Difference Between Equity Shares And Preference Shares

 

 

Similar to equity shareholders, some preference shares get dividends only when companies are earning profits and like debentures, preference shares get a fixed rate of return.

 

 

Types of Preference Shares

 

Unlike Common shares, there are different types of preference shares. These different types of preference shares are categorized into participatory, non-participatory, convertible, non-convertible, cumulative, non-cumulative, and so on.

 

1). Cumulative Preference Shares

In this type of preference share, shareholders are entitled to receive dividends every year irrespective that the company makes enough profit or not.

In case, the company incurred losses during a particular year and is unable to pay dividends to its shareholders, in such cases, the accumulated dividend is paid to preference shareholders in the subsequent years as arrears.

For example, if a company has issued cumulative preference shares with a maturity period of 10 years with 14% interest per annum. In such a case, if a company fails to give dividends in the 3rd and 4th years, then the liability of the company will keep on adding in the subsequent years till they pay it off.

 

2). Non-Cumulative Preference Shares

In such type of preference shares, the shareholders are entitled to receive dividends over common shareholders, if the company is in a position to give dividends.

In case, the company incurred losses during a particular year and is unable to give dividends to its shareholders, then in such cases, the arrears will not be carried forward to the subsequent years.

 

3). Convertible Preference Shares

These are the types of preference shares that can be converted into common shares after a fixed period. The period after which the shares will be converted into common shares is pre-determined in the terms and conditions.

Upon conversion into ordinary shares, the shareholders will be considered common shareholders and will not get the fixed dividends that they used to get every year and will enjoy the benefits of common shareholders.

 

4). Non-Convertible Preference Shares

These types of preference shares cannot be converted into common shares and such shares will complete their fixed maturity period.

Such shareholders have preferred dividend payments over common shareholders if the company is in a position to do so.

 

5). Redeemable Preference Shares

These shares are types of preference shares that are redeemable by the company once their maturity period is over.

Redeemable shares can be redeemed by the company upon its maturity. The shareholders get divided till the shares complete their maturity period and then the company will redeem these shares at a pre-determined price.

For example, if a company has issued a share at Rs.100 per share and has a maturity period of 5 years. It is stated that upon maturity, the company will redeem these shares at Rs.150 per share. Hence, the company will redeem the share at Rs.150 after the completion of 5 years.

 

6). Non-Redeemable/Irredeemable preference Shares

Irredeemable preference shares do not have any maturity date and you will not get any principal amount back on such shares.

In these types of preference shares, you will get a fixed dividend as per the terms and conditions of the issue.

These types of preference shares are also called irredeemable or perpetual preference shares. As per the Companies Act of 2013, issuing and buying non-redeemable shares is illegal in India.

 

7). Callable Preference Shares

In such types of shares, the company can buy back these shares from the shareholders on or after a pre-determined date.

These shares are different from redeemable shares as those shares are redeemed by the company after their maturity date whereas callable shares can be called upon by the company at a predetermined date and price even before the maturity date as per the terms and conditions.

For example, a company issues shares with a maturity period of 10 years at Rs.100 per share callable after 5 years at Rs.150 per share which means that the company call can buy back the shares anytime after 5 years at the predetermined price of Rs.150 per share.

 

8). Adjustable-Rate Preference Shares

Such shareholders do not get fixed dividends during their maturity and get returns based on the market rate eventually.

The company issues such shares to save itself from interest rate risk. Post issuing the share the company may lend money from the market at a lass interest rate, so to save themselves from the high cost of interest rate, companies issue such shares.

9). Participative Preference Shares

Such shareholders get the additional benefits of common shareholders apart from those of preference shareholders. The additional benefits they get are:

 

• Additional Dividends: In this case, if a company makes surplus profits in a particular year and decides to give additional dividends to its common shareholders more than the preference shareholders, then in such a situation, participative preference shareholders are also entitled to receive an additional dividend for that particular year similar to common shareholders.
• Liquidation event: If there is any liquidation event and the company is getting sold then in such a case, all preference shares will get their initial capital as well as a share from that of common shareholders on a pro-rata basis.

For example, upon formation, a company’s total share capital was 10 crores and preference shares comprised 2 crores and equity shares were worth 8 crores. In this case, the share of preference shareholders is 20% of the total share capital.

 

So, in the event of liquidation, if the company is valued at 15 crores, then participative preference shareholders will get their initial capital of 2 crores and an additional 20% on the remaining 13 crores(15 crores minus 2 crores initial capital) which will be worth Rs.2.6 crore. Hence, they will receive a total amount of 4.6 crores at the time of liquidation.

 

These are the two types of shares issued by companies: Equity shares and Preference shares. Both these types of shares have their benefits and downsides, where on one hand equity or common shareholders are more concerned with the growth of the company.

 

On the other hand, most preference shareholders are concerned with the timely payment of dividends rather than the company’s growth. It is important to go through the terms and conditions of the type of preference shares that you are going for and whether or not it suits your requirements.