Preference Shares: Explain, Features, Types, Advantages

August 20, 2020January 16, 2023 Sohini Mazumder 0 Comments

In my previous guide named “Equity Shares”, I had introduced the topic of Shares. We have come to know that shares are basically the owner of a company distributed in the form of Real Estate, Mutual Funds, and Partnership. Here, in this article, we will try to understand what are Preference Shares or widely known as Preferred Stocks.

What are Preference Shares?

Preference shares, commonly known as Preferred Stocks, are a company’s share where the dividends are paid to these shareholders before they are being paid to the Preferred shareholders. The Preferred shareholders can claim their assets from the company before the common stockholders during the shutdown of the company.

The Preference shareholder’s dividend is higher than any ordinary shares nonetheless, they carry no voting rights for the company.

Why It is Known as Preference Share?

At first, going by the word ‘Preference’, which means giving more importance to something, or prioritising it over something else. To be more precise, these types of shares gives the preferred shareholders a right to claim assets of the allotting company before the Common shareholders.

Thus, they are given the first preference over the assets of the company who have issued the shares, which is why these shares have been named as Preference Share.

Types of Preference Share:

1. Cumulative Preference Share:

If ever the issuing company has no enough finance to pay the dividends to their shareholders then here, under Cumulative preference share they can be paid in debts or to pay cumulative dividends in the next year. Without paying Dividends to these shareholders first, the company can’t pay dividends to Common shareholders.

2. Non-Cumulative Preference Share:

Non-cumulative preferred shareholders are to be paid dividends exclusively from a year’s profit.

3. Redeemable Preference Share:

Here, the issuing company has the full authority to buy back shares for their utility by giving the shareholders prior notice.

4. Irredeemable Preference Share:

These shares can only be redeemed by the issuing company during their shutdown or during the liquidation of the company.

5. Participating Preference Share:

Here, the issuing company pays the preference dividend, increased dividend, and also, they pay surplus profit to the Participating shareholders during the liquidation of the company.

6. Non-Participating Preference Share:

Under this type of share, the shareholders who are non-participating are to the dividends at a fixed rate only and they are not eligible for the surplus profit.

7. Convertible Preference Share:

Here, the Shareholders of such shares have the option to convert the common shares to preferred shares.

8. Non-Convertible Preference Share:

Under this type of share, the shareholders do not carry any privileges to convert the Preference share to the issuer’s common shares.

9. Preference share with a callable option:

In this category of Preference share, the issuing company bears the right to call in their shares at a fixed price after a set date.

10. Adjustable-Rate Preference Share:

Under this category of Preference shareholders, the rate of dividend is dependent on the ongoing interest rate in the market.

Features of Preference Shares:

The shareholders hold the authority to claim their dividend first from every issuing company.
The shareholders of Preference shareholders no voting right for the issuing company.
Dividends are paid to Preference shareholders on a particular date.

Advantages of Preference Share:

Preference shareholders have fixed dividends.
Preference shareholders have the option of a higher claim of assets of the business while the time it goes bankrupts or decides to file for liquidation.

Disadvantages of Preference Share:

Preference shareholders claim no voting right for the company, nor do they have any say on the working of the business.

The Preference shareholders are at a disadvantageous situation due to market fluctuations.

Why Should One Invest in Preference Shares?

A very common question that is important and veracious to ask oneself, “Why would I invest in Preference shares when I can’t vote?”

Well, the answer to this can vary from different perspectives, but few points can be taken under consideration while answering this question.

If the issuing company ever goes bankrupt then Preferred shareholders are given the first preference on the assets.

This point can excite the investors with Risk Averting quality. A risk Averting investors prefers incurring low risk overtaking high risk while investing. Claiming assets from the company can reduce its risk while investing.

Investors under Preference shares can also repurchase their shares whenever they want to. Transferring their preference share to ordinary shares, when the performance of the ordinary shares is outstanding can help the investors to enjoy lucrative returns.

With major market fluctuations, the dividend the shares might yield becomes questionable. Which means there is a risk in investing in Preference shares. Here Risk averting investors might not feel comfortable. This can only galvanize the investors with risk-taking quality to invest here.

Thus, it is advisable to decide to invest here after understanding one’s nature towards taking risks, as here both Risk Takers and Risk Averts can be benefited.

Also Read: How To Buy Shares [Complete Guide]