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.
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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.
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.
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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.
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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
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.
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.
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.
Non-cumulative preference shares: It is the opposite of cumulative preference shares. The dividends are paid out of profits every year.
Convertible preference shares: These shares can be converted into equity shares after a certain time period.
Non-convertible preference shares: These shares cannot be converted into equity shares at any time.
Redeemable preference shares: These shares can be returned or claimed after a fixed period of time or by issuing a due date notice.
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.
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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
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Advantages of Preference Shares
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Disadvantages of Preference Shares
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.
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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.
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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
Once a member of equity shares, equity shares cannot change to preference shareholder. However, Preference shareholders can change to equity shares.
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.
Equity shareholders do not get redemption while preference shareholders can avail redemption.
Equity shareholders have voting rights whereas preference shareholders do not.
(Related Reading: Common Stocks Vs Preferred Stocks)
4 Top Companies that offer Preference Shares
EIH limited: A flagship company of the Oberoi group which is also one of the largest luxury hotel chains in India.
CURA healthcare Pvt. limited : A Radiographic Imaging solutions provider.
TEGA Industries Limited : A company that deals with solutions to mining.
JSW(Jindal Steel Works)Steel Limited : An Indian multinational steel making company.
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.