What are Preference Shares and Should I Use Them?
There are a few different types of shares a business can opt to use. The most common type of shares are Ordinary Shares, however, this blog post is going to look at Preference Shares.
What are preference shares?
There are three main features of preference shares:
- Fixed-rate of dividend - the dividend is paid out before the other types of shares. In other words, they have preference over ordinary shares (and other share classes).
Any remaining profits available for distribution as dividends are paid out after the preference shareholders have been paid their dividends.
- Return of capital - if the company is wound up, preference shareholders are entitled to be repaid their capital contribution before ordinary shareholders. However, creditors are still given priority over shareholders.
- No voting rights - in general, preference shares generally do not come with any automatic voting rights.
What sub-types of preference shares are available?
- Cumulative - if the dividend isn't paid in respect to one financial period, it will accrue and be added to future dividend payments when profits improve.
- Convertible - you can convert them into ordinary shares.
- Redeemable - they can be bought back by the company (e.g. if an employee shareholder leaves the company)
What are the advantages of preference shares?
Preference shares generally offer a higher degree of security to their holders (compared to holders of ordinary shares). This is in terms of receiving a return on investment and recouping any losses should the company get into financial difficulty.
What are the disadvantages of preference shares?
Because of the fixed-rate, preference shareholders will not have the benefit of unexpectedly good profits, meaning they could receive a much lower dividend payment compared to ordinary shareholders.
When should preference shares be issued?
Some companies and investors view preference shares as an alternative to a loan arrangement. They provide the release of capital with a fixed rate of return, even though this does not involve debt and is therefore not a creditor relationship.
Another reason for issuing preference shares as opposed to ordinary shares is that they do not dilute the voting rights of existing shareholders. Meaning they can be good for companies who are looking for more investment, but who do not want to give up control held by existing shareholders.
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