Redemption of Preference Shares, Meaning and Methods

Redemption of Preference Shares : The term "redeem" refers to the act of buying back or settling a financial obligation. In finance, redeeming preference shares involves a company repurchasing its issued preference shares from its shareholders.

What Is Redemption of Shares?

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What is Redemption of Preference Shares?

Also Read: Difference Between Tangible and Intangible Assets

Reasons for Redemption of Preference Shares

1. Financial Restructuring : Companies may redeem preference shares to improve their capital structure, such as adjusting the balance between debt and equity to align with their financial goals.
2. Improving Financial Ratios : By redeeming preference shares, companies can enhance certain financial ratios, like earnings per share (EPS), making them more appealing to investors.
3. Tax Efficiency : In some cases, redemption is driven by tax benefits. While preference dividends are not tax-deductible, interest on debt is. Converting preference shares into debt can therefore offer tax savings.
4. Market Signaling : Redeeming preference shares may signal that a company is financially strong and confident in its cash flow, which can improve investor trust and boost stock prices.
5. Cost Reduction : If the dividend rate on preference shares is high, redeeming them can lower the company's cost of capital, especially if replaced by cheaper financing options.
6. Contractual Obligations : Some preference shares come with fixed redemption dates or conditions. Companies must redeem these shares to meet these contractual requirements.
7. Utilizing Excess Cash : Companies with surplus cash reserves may redeem preference shares to make effective use of their funds, providing additional value to shareholders.

Provisions of The Companies Act (Section 55)

Authorization : Preference shares can only be issued if the company’s Articles of Association permit it.

Shareholder Approval : Issuing preference shares requires approval through a special resolution at a shareholders' meeting.

Redemption Period : Preference shares must be redeemed within 20 years from the issue date.

Redemption Source : The redemption can be funded either from the company’s profits (that would otherwise be paid as dividends) or from the proceeds of a new share issue.

Capital Redemption Reserve : To redeem preference shares, the company must create a Capital Redemption Reserve and transfer an amount equal to the value of the redeemed shares from the company’s profits into this account.

No Convertible Preference Shares : The Act prohibits issuing preference shares that can be converted into equity shares after a specified period.

Dividend Payments : Dividends on preference shares can be paid according to the terms set at issuance, provided the company has sufficient profits and funds available.

Failure to Redeem : If the company fails to redeem the shares or pay dividends, penalties may apply, and the company’s directors may be held responsible.

Methods of Preference Share Redemption

Redemption from Profits :

Redemption through a Fresh Issue of Shares :

Redemption out of Capital :

Purchase of Own Shares :