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Preference Shares

•6 min read•by Angel One
Preference shares are shares that provide priority in dividends and capital repayment under the Companies Act, 2013. They offer fixed income, lower risk, and include types with different dividends, redemption, and conversion features.
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Preference shares are a class of share capital that provide investors with priority in dividend payments and capital repayment compared to equity shareholders. Under the Companies Act, 2013, companies in India can issue only redeemable preference shares. 

Understanding what are preference shares, also helps investors recognise their role as a hybrid instrument, combining features of both equity and fixed-income securities. They provide priority in dividend payments and capital repayment, making them useful for income-focused investment strategies. 

Key Takeaways 

  • Section 55 of the Companies Act of 2013 allows only redeemable preference shares to be issued in India. 

  • Unpaid dividends are carried forward by cumulative preference shares. 

  • During the liquidation process, preference shareholders rank above shareholders of equity but lower than debt holders. 

  • Preference shareholders have limited voting rights. 

What is Preference Share? 

Preference shares are shares that receive priority in dividend payments over equity shares. Preferred stock or preference shares entitle their holders to receive dividend payments before common shareholders when the company declares dividends.  

Preference shares can also be defined as holdings that give shareholders the right to receive priority in dividend payments whenever dividends are declared by the company. If the company underperforms and liquidates, preference shareholders are also eligible to claim repayment of capital before common shareholders.   

Types of Preference Shares 

Preference shares are issued in different forms based on dividend rights, conversion options, and redemption terms. Each type offers specific features that help investors choose based on income stability, flexibility, and investment objectives. 

  1. Cumulative Preference Shares 

Cumulative preference shares allow unpaid dividends to be carried forward to future years. If a company is unable to pay dividends in a particular year, the unpaid amount accumulates. These accumulated dividends must be paid before any dividend is given to equity shareholders. 

  1. Non-Cumulative Preference Shares 

Non-cumulative preference shares do not carry forward unpaid dividends. If the company does not declare dividends in a given year, shareholders cannot claim those unpaid amounts later. Dividend payments depend entirely on the company’s profitability in that specific year. 

  1. Redeemable Preference Shares

Redeemable preference shares can be repurchased by the issuing company after a specified period or on a fixed date. The redemption terms are defined at the time of issue. These shares help companies raise temporary capital without permanent ownership obligations. 

In India, companies can issue only redeemable preference shares, typically redeemable within a maximum of 20 years (30 years for eligible infrastructure projects, subject to minimum annual redemption conditions). 

  1. Irredeemable Preference Shares 

Irredeemable preference shares do not have a fixed redemption period. The Company Act of 2013 prohibits Indian corporations from issuing irredeemable preference shares. All new preference shares must be redeemed within a certain time frame (usually 20 years, but up to 30 years for qualifying infrastructure projects with phased redemptions). 

  1. Participating Preference Shares 

Participating preference shares allow investors to receive fixed dividends and additional dividends if the company earns higher profits. Shareholders may also receive a share in surplus assets during liquidation, after other obligations are met. 

  1. Non-Participating Preference Shares 

Non-participating preference shares provide only fixed dividend payments. Investors do not receive any additional shares in surplus profits beyond the agreed dividend amount. 

  1. Convertible Preference Shares 

Convertible preference shares can be converted into equity shares after a specified period or based on defined conditions. This feature allows investors to benefit from potential growth in the company’s equity value. 

  1. Non-Convertible Preference Shares 

Non-convertible preference shares cannot be converted into equity shares. These shares focus mainly on providing fixed dividend income without equity ownership benefits. 

  1. Preference Shares With a Callable Option

Callable preference shares allow the issuing company to buy back the shares at a predetermined price after a certain period. This gives companies flexibility in managing their capital structure.  

  1. Adjustable Rate Preference Shares 

Adjustable-rate preference shares have dividend rates linked to market interest rates. The dividend amount may increase or decrease depending on prevailing financial conditions, helping investors manage interest rate risk. 

Preferred Stock Example 

We can also define preferred stock through an illustration of how it works. As an example, suppose that a Company ‘C’ has a total of 10,000 preference shares to distribute among its investors.  

These shares are priced at ₹100, with a dividend rate of 8% per annum. For the years 2018, 2019 and 2020, C Company has not paid dividends to its preference shareholders.   

Now, before the company can pay its common shareholders, the preference shareholders must be paid any accumulated cumulative dividends, amounting to ₹2,40,000, if the company declares dividends. This amount represents the cumulative dividend for all preference shareholders over 3 years (2018, 2019, and 2020). Preference shareholders will get priority before other shareholders when the company starts paying its dividends.  

Preference Shares Features

Here’s how preference shares differ from common equity or debt: 

  • Dividend Preference: With a preference share, shareholders get the benefit of receiving the dividend payment on priority relative to non-preference stockholders.  

  • Voting Rights: Preference shareholders often do not have voting rights on ordinary company matters. They can, however, vote on decisions affecting their rights, such as winding up or capital reduction. They also get voting rights on all decisions if dividends on their class are underpaid for 2 years or more. 

  • Preference in Assets: In case the company liquidates, preference shareholders also get priority over the company’s assets and can claim them over non-preference shareholders.   

  • Convertibility: Preference shares may have the option of being converted into a predetermined number of equity shares, based on the terms of issue. If an investor wishes to alter their holding position, they have this option. Depending upon the company, preferred stock has the option to be converted prior to a specific date or might require the permission of the board of directors.   

  • Callability: At some point in the future, the issuing company may repurchase callable preference shares based on predefined terms. When the company buys back these shares, the outstanding preference share capital reduces, and may alter its capital structure. 

Also Read: What is Share Capital? 

Preference Shares Benefits 

Preference stock offers advantages to both its stockholders and the issuer. These advantages are divided into both categories. When it comes to the benefits offered to an investor, preferred stock helps as follows:  

  • Secured position: When compared to common shareholders, those with preferred stock have a significantly more secure position in the capital structure than equity shareholders, as they rank shareholders ahead of equity in dividend payments and capital repayment during liquidation. 

  • Fixed income: Depending on the company and the type of preference share chosen, investors receive a fixed passive income through regular dividend payouts.   

Preferred Stocks Offer the Issuer the Following Benefits:  

  • Flexibility: The management and board of directors of a company also enjoy flexibility in setting up the use of preferred stock in the way in which they see fit. They can allocate the ratio of preference shares most suited to their company to attract investors.   

  • No immediate dividend obligation: In cumulative preference shares, the company may defer dividend payments if profits are insufficient, but unpaid dividends accumulate and must be paid before equity shareholders receive dividends. 

Conclusion 

Under the Companies Act of 2013, preference shares are a type of share capital that receive priority in dividend distribution and capital repayment above equity shares. Companies in India may only issue redeemable preference shares, subject to the guidelines stipulated in Section 55. Understanding the structure, types, and legal regulations governing preference shares allows readers to better comprehend how these instruments fit into a company's capital structure and shareholder hierarchy. 

FAQs

With redeemable preference shares, a company can buy back or redeem from shareholders after a specific period or on a set date. The terms of redemption are usually mentioned when the shares are issued. These shares give investors priority in dividend payments, as per the terms of issue, and a clear exit option once the company redeems them.   

Preference shares play an important role in balancing risk and return for both investors and companies. For investors, priority in dividend payments and capital repayment over common shareholders, subject to dividend declaration and company performance. For companies, they help raise capital without diluting voting rights. They also attract conservative investors who seek steady income rather than high-risk market gains.   

Preference shares are a class of shares that give investors priority in dividend payments and capital repayment. These shareholders receive dividends before equity shareholders. However, they usually do not have voting rights in company decisions. 

Preference shares are generally considered less risky than equity shares due to fixed dividend priority. They also provide preference during capital repayment if the company is liquidated. However, they still carry some risk, depending on the company’s financial stability. 

Preference shares include cumulative, non-cumulative, redeemable, participating, and convertible types. Each type differs based on dividend payment, redemption, and conversion features. These variations allow investors to choose shares based on income needs and investment goals. 

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