Published on: Oct 6, 2017 9:59:28 AM
Many of you have asked just what a preference share is, and how it differs from your standard issue share. Here's a simplified version of just what they are and do for the investor, and why companies issue preference shares in the first place.
If a company – which already has equity shareholders – needs to raise more funds, there are a couple of ways to do it. They can:
- Issue more shares, but this means that the value of shares owned by existing shareholders is diluted. It also means they have to file a public issue, which can be quite a schlep.
- Take a loan - but meh, loans mean paying back the money with interest, regardless of whether the venture they require the extra funding for makes profit or not
OR
- Issue preference shares, which is a combination of two options above. They offer the shareholder first dibs when it comes to dividend pay-outs as well as the repayment of capital, should the company get liquidated.
There are a few other differences, and many depend on the particular share in question. Below is a basic comparison between preference and equity shares to give you an idea:
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Equities
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Preference Shares
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Voting rights
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Nope, no voting rights
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Dividend rate isn’t fixed – it can change from year to year
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Dividend rate is fixed, you get the same rate every time there is a pay-out
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Equity share dividends get paid out after preference shares if there is enough profit
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Preference share dividends get paid out first and only if there is sufficient profit
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If the company doesn’t make enough money to pay a dividend for a particular year, sorry for you, you just don’t get it
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If a company can’t pay dividends in a particular year, it gets carried over and paid out when a dividend can be paid
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Shareholders are only paid out if and when the company is liquidated
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Shareholders have to be paid back their initial investment after a period of time
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If a company liquidates, it will settle all of its liabilities, pay preferential shareholders and only then pay equity shareholders
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If a company liquidates, it will settle all of its liabilities, and pay preferential shareholders before paying equity shareholders
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