Preference Shares Meaning
Preference shares are defined as those shares which are given priority over other equity shares in terms of the payment of dividends. Preference shares are held by preference shareholders who are the first to receive payouts in case the company decides to pay its investors any dividends. Hence, another way to define preference stock are those holdings whose shareholders have the right to claim dividends during the lifetime of a company. The same shareholders also can claim repayment of capital in case the company underperforms.
Preference Shares Features:
Preference shares differ from common equity or debt along the following lines.
Preference in assets: Upon liquidation, one sees preference shares giving their holders priority over non-preferential stockholders when it comes to claiming a company’s assets in case of liquidation.
Dividend payouts: Preferential shares uniquely allow holders to receive dividend payouts in situations where other stockholders may not be receiving any dividends or may receive dividends later. The payouts can be fixed or floating, which is a factor of the interest rate benchmark.
Dividend Preference: As explained earlier, with a preference share a shareholder has the advantage of receiving the dividend payment first — or on priority — in comparison to other stockholders.
Voting Rights: In some cases, preference shareholders can receive the right to vote in case of extraordinary events. Generally, buying stock in a company does not give one voting rights in the company’s management.
Convertibility: Preference shares can also be converted into common stock. They are typically converted into a predetermined number of non-preference stocks if one wants to change their holding position. Some preference shares inform investors that they can be converted beyond a specific date, while others may require permission and approval from the company’s board of directors to be converted.
Callability: Preference shares features also include their ability to be called or repurchased by the issuer at some point in the foreseeable future. Similar to being converted, one can reissue their preference share at some specific future date as specified by the company.
Preferred Shares Types
There is a lot of flexibility in the type of preferred stock one can choose from. Which preferred stock one receives depends upon the type offered by the company they are buying from.
Convertible preferred shares: As described this type of preferred stock can be converted to a certain number of common stock.
Perpetual preferred shares: These preference shares are such that there is no fixed date specifying when shareholders will receive back invested capital.
Exchangeable preferred shares: This type of preferred stock can be exchanged for another type of security if need be.
Cumulative preferred shares: These types of preference shares allow a missed dividend payment to be cumulatively added to the next one.
Preference Shares Advantages
Beyond giving investors priority in their dividend payments, preference stock offers advantages to both the issuer and the stockholder. These advantages are divided into both these categories.
The issuer receives the following benefits:
No dividend obligation: Cumulative preferred shares allow the issuer the freedom to defer their dividend payouts. In case the company lacks enough dividend funds, they are no longer obligated to pay their investor and can defer this payment to next month.
Flexibility: The company’s board of directors and management enjoys the flexibility to sue preferred stock as a means of setting up terms for the shares that they see fit.
When it comes to the benefits afforded to an investor, preferred stock helps as follows:
Secured position Those with preferred stock are in a significantly more secure position in case of the company’s liquidation relative to common shareholders. The former has the advantage of claiming a company’s assets first.
Fixed income: Depending upon the type of preference share chosen and the company one has bought stock in, investors can receive a fixed passive income from preference stock in the form of dividend payouts.
Preference shares are a wise way to earn a priority position in a company’s group of shareholders. In case the company sees liquidity in its stock, one gets the unique advantage of claiming dividend payments. Issuers also have the flexibility to set terms and conditions for preferred shareholders as they see fit, with some affording holders voting rights in extraordinary circumstances.