Capital (money or equivalent to money, etc.) is the lifeline of any business because without it, a business can never start or run. Every step of business involves financial activity like buying, selling, spending, etc., for which capital is required, and it can be raised in many ways, like owner’s investment, loans, shares, bonds, securities, etc., but it depends on the nature or type of business.
Raising capital through shares is common in companies, but the nature of the company influences this. There are two types of shares: equity shares and preference shares. Businesses that do not wish to grant shareholders rights such as voting rights or participation in the management of the business issue preference shares. Preference shares are further divided into several types, and companies issue them as per their convenience.
Preference shares can only be issued by a company, and this is regulated by law, and subscription is affected by the type of company, as the type of company determines the minimum and maximum number of members required to subscribe for its shares. If the company is listed on a stock exchange, trading of shares is regulated by the country’s stock exchange board.
Table of Contents
What is a Preference Share?
A preference share is a type of share and an instrument used to raise capital from investors in a company. It represents ownership in the company, and the one who holds it is called a shareholder, and the shareholder has ownership in the company as much as the number of shares he holds. In simple terms, a preference share is a portion of a company’s ownership that is issued in exchange for ownership of the company, and each preference share has a unique identification number that distinguishes it from others.
A preference share has certain privileges, such as a fixed dividend, priority in dividend payment, priority in liquidation, etc., which attract investors. Because of these privileges, it is more secure than equity shares. For example, if a company winds up, the preference shareholder is paid first, followed by the equity shareholder. Along with these privileges, it also has certain restrictions, such as no voting rights, no participation in management, etc., but the type of shares can affect it.
A preference share is transferable, which means the shareholder is eligible to transfer their preference share to someone else’s name, but legal compliance is required for this, and it is perpetual in nature, which means transfer of a preference share does not affect its existence, but its type may affect it. Note: Transferability of share depends on the type of company, as the type of company affects the transferability of share.
A preference share is recorded in the books of accounts, such as the ledger book, final account (balance sheet), etc., and is traded like equity shares. Note: If the company is listed, then it is traded in the stock exchange, and if not listed, then it is traded manually and its trading is regulated as per the law (Stock Exchange Board, MOA, AOA, etc.).
A preference share can be converted into equity shares if it falls under the category of a convertible preference share. This feature provides mobility because the shareholder can convert their preference share into an equity share if they wish. If investors want fixed dividends and a safer investment (compared to equity shares), this is the best source because it acts like both debt and equity, making it a hybrid. Note: Capital raised through preference shares is not a loan to a company.
Features of Preference Share
Following are the features of preference share:
1. Instrument:
A preference share is an instrument (means) of raising capital from investors, and it is available only in a company, as only those businesses are entitled to raise capital by issuing preference shares that are registered as a company under the Companies Act or equivalent legislation. Each preference share has its own unique number and other formalities that make it authentic, and it is governed by law.
2. Portion:
A preference share is a portion (part) of the ownership or authorized capital of the business, and each preference share has a unique identity and has some value (Ownership). For example, if the authorized capital is Rs 1 crore and it is divided into 1 lakh shares, then in this scenario, there are 1 lakh shares, which are called part of the authorized capital, and the value of each share is Rs 100. Dividing the authorized capital into multiple shares helps in attracting more investors, as it increases the investment potential of the investor.
3. Secured:
A preference share is more secure than equity shares because preference shareholders receive preferential treatment if the company is liquidated. For example, if a company is liquidated, the company first begins paying off its debts, then paying preference shareholders, and then, if funds are available, paying equity shareholders.
4. Governed:
A preference share is governed by internal and external laws, such as the business’s Articles of Association (AOA) and Memorandum of Association (MOA), company laws, and governing laws, etc. It is a legal instrument and has the ownership of the business, hence it is governed by law. If the share is of a listed company, then it is also governed by the stock exchange board of the country.
5. Ownership:
A preference share represents the ownership of the business as the business uses it to transfer ownership to investors in exchange for capital. Without getting anything in return, investors do not invest in the business; for this, the business gives them ownership, and it is equal to the investor’s investment.
6. Preference:
A preference share has the feature of priority on various events, due to this, the preference shareholder gets priority over the equity shareholder at the time of payment of dividend, at the time of winding up of business, this feature makes it more attractive and safe than equity shares, but both types of shares have their own features which make both different from each other.
7. Perpetual:
A preference share is perpetual in nature, i.e., it is not affected by the change of its owner or transfer of ownership. It continues to exist as long as the business exists and ceases to exist with the discontinuation of the business, but its type does affect it. This feature is similar to and linked with the perpetual feature of a company because when members change, the owner of the share also changes, and vice versa.
8. Classified:
A preference share is classified into different types, such as cumulative preference shares, non-cumulative preference shares, redeemable preference shares, non-redeemable preference shares, participating preference shares, non-participating preference shares, convertible preference shares, non-convertible preference shares, etc., and each type has its own characteristics that make it different from the other.
9. Transferable:
A Preference share is transferable in nature, which allows shareholders to transfer it to another, but the type of company affects it. For example, in a one person company, transfer of shares is restricted as only one member is allowed to hold the entire share, in a private company, transfer of shares is allowed but with certain restrictions, in a public company, there is no restriction on the transfer of shares.
Types of Preference Share
Following are the types of preference shares:
| Cumulative Preference Shares | Unpaid dividends continue to accumulate. |
| Non-Cumulative Preference Shares | Unpaid dividends are not accumulated. |
| Redeemable Preference Shares | The company takes it back after maturity. |
| Non-Redeemable Preference Shares | The company does not take it back until liquidation. |
| Participating Preference Shares | This allows the shareholders to participate in the surplus profit or residual dividends. |
| Non-Participating Preference Shares | This does not allow the shareholders to participate in the surplus profit or residual dividends. |
| Convertible Preference Shares | In this, the shares can be converted into equity shares. |
| Non-Convertible Preference Shares | In this the shares cannot be converted into equity shares. |
1. Cumulative Preference Shares:
Cumulative preference shares are a type of preference share in which unpaid dividends continue to accumulate for the next year or until the dividend is due. For example, if the company did not pay a dividend this year, this year’s dividend is added to the upcoming dividend payment. Simply put, shareholders never miss a dividend payment; if it is not received this year, it is received next year, along with the previous pending dividend.
2. Non-cumulative Preference Shares:
Non-cumulative preference shares are a type of preference share and are opposite to cumulative preference shares in that the dividend does not accumulate. If the company does not pay a dividend this year, it will never be received by the shareholders and will lapse. Simply put, if shareholders do not receive a dividend payment this year, it will not accrue to the next year, as is the case with cumulative preference shares.
3. Redeemable Preference Shares:
Redeemable preference shares are a type of preference share that has a maturity date. Upon maturity, the issuing company redeems or buys them back at a specified price and terms. If there is an anytime buyback or redemption provision, the company can redeem them at any time if needed. Note: By their nature, these shares are temporary.
4. Non-redeemable Preference Shares:
Non-redeemable preferred shares are a type of preference share that does not have a maturity date, meaning they cannot be redeemed or bought back by the company until the winding-up process. They are the opposite of redeemable preferred shares and, by their nature, are perpetual.
5. Participating Preference Shares:
Participating preference shares are a type of preferred share that provides shareholders with a fixed dividend and a share in the remaining dividend or surplus profits. Simply put, they offer the opportunity to receive additional dividends. For example, shareholders receive a fixed dividend rate as defined in the share, and they are also entitled to additional dividends if the company has a surplus.
6. Non-participating Preference Shares:
Non-participating preference shares are a type of preference share that, unlike participating preference shares, do not allow shareholders to participate in residual dividends or surplus profits. Shareholders receive only a pre-determined dividend rate. These shares are generally less preferred by shareholders than participating preference shares.
7. Convertible Preference Shares:
Convertible preference shares are a type of preference share that allows the shareholder to convert their shares into equity shares. The provision for share convertibility is stated in the terms and conditions which is formed at the time of issuance of shares. This is the best option if the shareholder wishes to convert their shares into equity shares in the future.
8. Non-convertible Preference Shares
Non-convertible preference shares are a type of preference share that does not allow shareholders to convert their shares into equity shares. This is the opposite of convertible preference shares because they allow shareholders to convert their shares into equity shares, but this is not allowed in this type. This type of share has a lower priority than convertible preference shares.
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QNA/FAQ
Q1. What is a preference share?
Ans: A preference share is a type of share and an instrument used to raise capital from investors in a company.
Q2. Do preference shareholders get a fixed dividend?
Ans: Yes, preference shareholders get a fixed dividend.
Q3. Does preference share has ownership?
Ans: Yes, there is ownership of preference share.
Q4. Write the classified type of preference shares.
Ans: Following are the classified types of preference shares:
1. Cumulative Preference Shares
2. Non-cumulative Preference Shares
3. Redeemable Preference Shares
4. Non-redeemable Preference Shares
5. Participating Preference Shares
6. Non-participating Preference Shares
7. Convertible Preference Shares
8. Non-convertible Preference Shares
Q5. Write the features of a preference share.
Ans: Following are the features of preference share:
1. Preference share is a means of raising capital.
2. Preference share is a part of the ownership of the business.
3. Preference share can be transferred to another person.
4. Preference share represents the ownership of the business.
5. Preference share is secured as compared to an equity share.
6. Preference share is permanent in nature except redeemable share.
7. Preference share is governed by law.
8. Preference share does not provide meeting and voting rights.
9. Preference share provides a fixed dividend to its members.
