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What are Preference Shares?

Preference Shares are the shares that guarantee the holder a fixed and steady dividend, whose payment takes priority over the equity share dividends. Capital raised by the issue of preference share is termed preference share capital.

Features of Preference Shares

  1. Preferential dividend option for shareholders.
  2. Preference shareholders do not have the right to vote.
  3. Shareholders have a right to claim the assets in case of a wind-up of the company.
  4. The fixed dividend payout for shareholders, irrespective of profit earned.
  5. Acts as a source of hybrid financing.

Types of Preference Shares

The various types of preference share are discussed below:

  1. Cumulative preference shares: They are a special type of share that entitles the shareholders to enjoy a cumulative dividend payout at times when a company is not making profits. These dividends will be counted as arrears in years when the company is not earning profit and will be paid on a cumulative basis, the next year when the business generates profits.
  2. Non-cumulative preference shares: These types of shares do not accumulate dividends in the form of arrears. In the case of non-cumulative preference shares, the dividend payout takes place from the profits made by the company in the current year. If there is a year in which the company doesn’t make any profit, then the shareholders are not paid any dividends for that year and they cannot claim dividends in any future profit year.
  3. Participating preference shares: These types of shares allow the shareholders to demand a part in the surplus profit of the company in the event of liquidation of the company after the dividends have been paid to the other shareholders. In other words, these shareholders enjoy fixed dividends and also share a part of the surplus profit of the company along with equity shareholders.
  4. Non-participating preference shares: These shares do not yield the shareholders the additional option of earning dividends from the surplus profits earned by the company. In this case, the shareholders receive only the fixed dividend.
  5. Redeemable Preference Shares: These can be repurchased or redeemed by the issuing company at a fixed rate and date. These types of shares help the company by providing a cushion during times of inflation.
  6. Non-redeemable Preference Shares: Those shares that cannot be redeemed during the entire lifetime of the company. In other words, these shares can only be redeemed at the time of winding up of the company.
  7. Convertible Preference Shares: They are a type of shares that enables the shareholders to convert their preference shares into equity shares at a fixed rate, after the expiry of a specified period as mentioned in the memorandum.
  8. Non-convertible Preference Shares: They cannot be converted into equity shares. These shares will only get a fixed dividend payout and also enjoy a preferential dividend payout during the dissolution of a company.

Advantages of Preference Share

  1. It does not influence the control of equity shareholders over the management.
  2. There may be a hike in dividends for the equity shareholders in the good time.
  3. The income of the shareholders is steady and fixed.
  4. They have a preferential power of repayment over the equity shareholders.
  5. Any sort of charge against the assets of a company is not created by the preference capital.

Disadvantages of Preference Share

  1. The amount of dividends is higher than the rate of interest on debentures.
  2. The dividend on these shares is regulated by the revenue of the company.
  3. Risk lovers will not prefer this kind of share.
  4. Claims of equity shareholders are diluted by the preference capital.
  5. It is not possible to deduct the dividend paid from the profits as an expense.