Preference Shares: Meaning, Types and Examples

Preference shares, sometimes also known as preferred stock, are a kind of stock that allows owners to receive dividends declared by the firm before equity stockholders.

Preference shares provide owners a particular right to receive dividends throughout the company's existence, as well as the possibility to get capital return if the firm goes bankrupt.

It is regarded as a hybrid security since it combines the features of both debt and equity investments.

Definition of Preference Shares

A preference share represents a form of ownership interest in a corporation. Unlike common shares, preference shares grant certain advantages to their holders, typically in the form of fixed dividend payments and a higher priority in the distribution of assets during liquidation.

Preference shares are so named because their owners have a preference over common shareholders when it comes to receiving dividends. In the event of a company's liquidation or bankruptcy, preference shareholders are also prioritized ahead of common shareholders in receiving their share of the remaining assets.

Features of Preference Shares

Preference shares possess distinct features that set them apart in the realm of corporate ownership. These characteristics include:

Fixed Dividends: Preference shareholders receive consistent, predetermined dividend payments.

Priority in Liquidation: In case of liquidation, they are ahead of common shareholders in asset distribution.

Limited Voting Rights: Typically, preference shareholders have restricted or no say in company decisions.

Cumulative Dividends: Unpaid dividends often accumulate and must be settled before common shareholders receive any.

Convertibility: Some preference shares can be converted into common shares, enabling potential equity ownership.

Redemption Option: Issuers may have the option to buy back preference shares at a specified price.

Callable Shares: Companies can redeem preference shares before their maturity date.

Non-Voting Preference Shares: Some types offer no voting rights, ensuring control remains with common shareholders.

Preferred Access to Dividends: They have precedence in dividend payments over common shareholders.

Income Stability: Preference shares are favored for their stable dividend income.

Types of Preference Shares

Preference shares are of various types, each with unique features that cater to different investor preferences and corporate needs. The common types include:

Cumulative Preference Shares: These shares ensure that any missed dividend payments accrue and must be paid out in the future before common shareholders receive any dividends.

Non-Cumulative Preference Shares: Unlike cumulative shares, missed dividends on non-cumulative preference shares do not accumulate. If a company skips a dividend, it is not obligated to make up for it in the future.

Convertible Preference Shares: Investors holding these shares have the option to convert them into common shares of the company. This feature provides potential for capital appreciation.

Non-Convertible Preference Shares: These shares cannot be converted into common shares, making them a more stable investment choice without the potential for equity ownership.

Redeemable Preference Shares: Issuers can redeem these shares at a specified price, providing flexibility in managing their capital structure.

Non-Redeemable Preference Shares: Unlike redeemable shares, non-redeemable preference shares do not grant the issuer the right to buy them back from shareholders.

Participating Preference Shares: Investors with preference shares are entitled to receive additional dividends, often a share of the company's profits beyond the fixed rate, along with common shareholders.

Non-Participating Preference Shares: These shares limit preference shareholders to only receive fixed dividends without the potential for additional participation in company profits.

Adjustable-Rate Preference Shares: These shares have dividend rates that can change over time based on specific conditions or benchmarks, providing flexibility to adapt to varying financial circumstances.

Perpetual Preference Shares: Perpetual preference shares have no fixed maturity date, allowing them to remain outstanding indefinitely unless the issuer chooses to redeem them.

What is an Equity Share?

An equity share, also referred to as common stock, indicates a kind of ownership in a firm. Equity stockholders are the genuine owners of the firm, and they have the capacity to benefit from its profitability and expansion. These shareholders possess voting rights and may participate in critical decisions at shareholders' meetings, enabling them to influence the company's future.

The key feature of equity shares is their fluctuating dividend payments. Unlike preference shares, which give set dividends, equity owners receive dividends dependent on the company's profitability and the board of directors' actions.

Preference Share Vs. Equity Share

Preference and equity shares are two distinct forms of ownership in a corporation, each with unique characteristics and benefits. Understanding their differences is essential for investors and companies when making financial decisions. Here is a comparison of preference shares and equity shares in a tabular format: