Learn how preference shares work, offering fixed dividends and liquidation priority. Understand their features, benefits, and role in corporate financing.
Preference shares are a class of shares that provide investors with a fixed income and priority in dividends and liquidation over ordinary shares. These shares combine features of equity and debt, offering fixed dividends with limited risk exposure. Companies use them to raise capital without significantly diluting ownership.
Preference shares, also referred to as preferred stock, are a class of equity security that grants holders a fixed dividend priority over common stockholders. Additionally, they typically have a higher claim on company assets during liquidation than common shareholders. However, they generally do not have voting rights in the company, except in certain circumstances.
Preference shares come with several key characteristics:
Dividend: Preference shareholders are entitled to receive dividends before common shareholders.
Fixed Return: Preference shares typically offer a fixed rate of return, providing predictable income to investors.
Priority: In the event of liquidation, preference shareholders have a superior claim on the company’s assets compared to common shareholders.
Limited Voting Rights: Preference shareholders generally do not have voting rights, though exceptions may apply under specific circumstances.
There are several types of preference shares available in India, each with distinct features. Here’s a breakdown of the major types:
| Type of Preference Share | Description |
|---|---|
| Cumulative |
Dividends accumulate if not paid in one year and are paid in the future. |
| Non-Cumulative |
Dividends are not carried forward if not paid in one year. |
| Participating |
Shareholders can participate in company profits beyond the fixed dividend. |
| Non-Participating |
Shareholders do not participate in extra profits beyond the fixed dividend. |
| Redeemable |
Can be bought back by the company after a specified period. |
| Irredeemable |
Cannot be bought back by the company during the tenure of the preference shares. |
| Convertible |
Can be converted into equity shares after a specified period. |
| Non-Convertible |
Cannot be converted into equity shares under any circumstance. |
Preference shares offer several advantages for both investors and companies:
For Investors: Preference shares offer fixed dividend payments and priority over common equity in liquidation, characteristics that are often associated with lower relative investment risk.
Despite the advantages, there are some limitations to preference shares:
Limited Voting Rights: Preference shareholders commonly have limited or no voting power, which reduces their influence on company decisions.
Limited Upside: Since the dividend is fixed, preference shareholders do not benefit from any appreciation in the company’s stock value beyond the dividend.
Redemption Terms: Companies may redeem preference shares at times that are less favorable for shareholders.
Preference shares combine features of both debt and equity, offering fixed returns along with dividend and liquidation priority over common shares. While they provide stability in income and capital structure, they also carry limitations such as fixed returns and limited voting rights, and are typically considered in context-specific investment frameworks.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The four main types of preference shares are cumulative, non-cumulative, participating, and non-participating. Each type has unique features regarding dividend payments and shareholder participation in profits.
Preference shares offer fixed dividends and priority in case of liquidation, whereas ordinary shares provide variable dividends and voting rights, but with lower priority in liquidation.
Equity shares give shareholders voting rights and a claim on company profits, but dividends are not guaranteed. Preference shares provide fixed dividends and priority in case of liquidation, but typically do not carry voting rights.
Preference shares are typically issued by companies seeking to raise capital without diluting ownership. They are often issued to institutional investors or individuals seeking stable returns.
Eligibility for preference shares typically depends on the company's issuance terms. Generally, institutional investors or high-net-worth individuals (HNWIs) are more likely to invest in preference shares.
Since April 2020, dividends from preference shares are taxable in the hands of investors as per their income tax slab. Companies no longer pay Dividend Distribution Tax (DDT), though TDS may apply on higher dividends.
Dividends on preference shares are generally mandatory, but they may be deferred in the case of non-cumulative preference shares if the company’s financials do not support dividend payments.
Preference shares are calculated based on the dividend rate, which is typically a percentage of the par value of the share. The total dividend is the dividend rate multiplied by the par value of the shares held.