What are Preference Shares? Preference Shares V/s Equity Shares

A share is something that represents the ownership of a company. When individuals buy shares in a company, they become part of its ownership.

 

Shares make up an  important characteristic of a business because investing in shares, buying and selling of shares can help the corporation quickly gain a lot of capital, raise the prestige of the company with the public as people can now invest in the company. 

 

(Related Reading: Equity Financing: Sources, Advantages & Disadvantages)

 

Therefore, it is necessary to understand the different types of shares that businesses offer. In this blog, let us look at preference shares, also known as preferred stock in particular and try to understand the different aspects of the same. 

 

 

Preference Shares

 

 

While looking at preference shares, it is mostly confused with equity shares as they both are similar but still hold a difference. 

 

Preference shares are considered to be highly valuable as they are linked to elements such as dividend distribution at a fixed rate and capital payback in the event of a company's collapse.

 

(Learn More: ETF Dividends: Types, Working, and Examples)

 

Preference shares have a fixed dividend which is first paid to preference shareholders and then to common shareholders. In short, preference shares are given more importance and priority than common shares. 

 

 Just like other shares, preference shareholders or investors have a part of ownership in a company. However, preference shareholders do not get the right to vote. But, they do have the right to vote in matters which affect their rights such as reduction in capital or the shut down of a company or loss faced by the company.

 

(Related Reading: Common Stocks Vs Preferred Stocks)

 

 

Who can hold Preference Shares?

 

Preference shares are held by promoters or managing directors of companies, etc. These shares are rarely seen as held by retail investors. You might want to learn about the difference between private and public limited companies, check out our blog here. 

 

 

Types of Preference Shares

 

 

1. Participating Preference Shares: These shares have the right to participate in additional profits, after paying equity shareholders. These shareholders get surplus profit. This surplus profit is apart from the fixed dividend paid up for preference shares. 

 

2. Non-participating Preference Shares: These shares do not have the right to participate in additional/surplus profits or surplus gained at the time of liquidation of a company. It refers to only the fixed rate of the dividend. 

 

3. Cumulative preference shares: Just as the name suggests, cumulation or collection of the dividend. This occurs when all the dividends can be carried forward until specified, and it is paid out only at the end of the specified period. 

 

4. Non-cumulative preference shares: It is the opposite of cumulative preference shares. The dividends are paid out of profits every year. 

 

5. Convertible preference shares: These shares can be converted into equity shares after a certain time period. 

 

6. Non-convertible preference shares: These shares cannot be converted into equity shares at any time. 

 

7. Redeemable preference shares: These shares can be returned or claimed after a fixed period of time or by issuing a due date notice. 

 

8. Irredeemable preference shares: These shares cannot be claimed or redeemed during the life-time of the company but can only be obtained at the time of winding up. 

 

 

Purpose of Preference Shares

 

Preference shares are issued with a motive to raise capital. These are highly valued as they stabilize the shares in terms of dividends and bankruptcy liquidation. 

 

(Related Reading: An Introduction to Capital Budgeting)

 

Preferred shares enable companies to get funds as some investors prefer more consistent dividends and stronger bankruptcy protections than common shares offer. You might want to read about top investors, check out our blog on Top 10 Investors of all time. 

 

 

Features of Preference Shares

 

 

• One of the key feature of preference shares is that it pays regular dividends of a fixed rate; part of the profit of the company to the shareholders irrespective of the profit gained. This dividend is not subjected to tax deduction. 

 

(Related Blog: 13 Types of Taxes)

 

• Preference shares are also considered as a long term source of finance  and investment. Check out our blog on Debentures and Mutual Funds to learn more about long term sources of finance. 

 

• At the time of liquidation, preference shareholders have a right on the assets of a company.  (Must Check: 4 Types of Financial Risk)

 

• Preference shares hold a high face value as compared to other shares such as equity shares. 

 

• Preference shareholders possess preferential rights that can be applied for the repayment of capital in case of winding up of the company. They can also apply their preferential right to receive dividends.

 

 

Advantages of Preference Shares

 

• Preference shares are valued over most others as the shareholders do not possess any voting rights. As a result, it does not affect the decision making of a company. 

 

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• Although the dividend rate keeps fluctuating, at the time of payment of dividend, preference shareholders are given more priority than other shareholders.

 

• They also have a greater claiming right over company assets in-case of bankruptcy or liquidation. 

 

 

Disadvantages of Preference Shares

 

• The only major disadvantage of this share is that the owners do not enjoy voting rights like other shareholders. This also means that they cannot have control over the management of the company. 

 

• Preference shares also receive low returns; when the company gains high profit, the fixed rate of dividend received by the shareholders seems to be unattractive. 

 

• It also faces a limit in-case of appeal to shares, this is because most investors prefer debentures and government securities. Therefore, the companies offering preference shares are forced to fix a higher rate of dividend which will attract investors. 

 

• Preference shares cannot be deducted from taxes and hence are said to be more expensive than debentures. 

 

• With respect to redemption, preference shares pose pressure on the company and affect the capital base. 

 

(Related Reading: A Beginner’s Guide to Tracker Funds)

 

 

Preference Shares V/s Equity Shares

 

Preference shares are those that a company issues in order to raise the capital of the company . These shares are given more importance as compared to equity shares as they offer a dividend of a fixed rate along with repayment of capital if in case the company goes into liquidation state.

 

Preference shareholders are part of the ownership of the company. However, they do not get any voting rights in matters such as winding up of the company or reduction of capital. 

 

(Must Check: What are Lupa Stocks?)

 

On the other hand, equity shares stand for ordinary shares of the company. These shareholders are the original owners of the company. 

 

The power that these shareholders possess is that they get voting rights at the general meetings unlike preference shareholders.

 

They also have the potential to appoint or remove directors or auditors in a company.

 

They are also eligible to gain profits and do not have a fixed rate of dividend. More the profit more the dividend and vice versa.

 

 

Key Differences between Preference Shares and Equity Shares

 

1. Once a member of equity shares, equity shares cannot change to preference shareholder. However, Preference shareholders can change to equity shares. 

 

2. In case of equity shares, the dividend is paid after the payment of liabilities. Whereas preference shareholders are given first priority in pay of dividend. 

 

3. Equity shareholders do not get redemption while preference shareholders can avail redemption. 

 

4. Equity shareholders have voting rights whereas preference shareholders do not. 

 

(Related Reading: Common Stocks Vs Preferred Stocks)

 

 

4 Top Companies that offer Preference Shares

 

1. EIH limited: A flagship company of the Oberoi group which is also one of the largest luxury hotel chains in India.

 

2. CURA healthcare Pvt. limited : A Radiographic Imaging solutions provider.

 

3. TEGA Industries Limited : A company that deals with solutions to mining. 

 

4. JSW(Jindal Steel Works)Steel Limited : An Indian multinational steel making company.

 

 

Conclusion

 

In conclusion, one can say that preference shareholders are greater and superior over equity shareholders, as they are given first priority. They also benefit from companies if there is a shut down or the company has to wind up, because they receive their dividend at any cost.  However, investors are required to have full knowledge about the share market.