What Are Preference Shares?

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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:

  1. 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.
  2. 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:

 

Equities

Preference Shares

Voting rights

Nope, no voting rights

Dividend rate isn’t fixed – it can change from year to year

Dividend rate is fixed, you get the same rate every time there is a pay-out

Equity share dividends get paid out after preference shares if there is enough profit

Preference share dividends get paid out first and only if there is sufficient profit

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

If a company can’t pay dividends in a particular year, it gets carried over and paid out when a dividend can be paid

Shareholders are only paid out if and when the company is liquidated

Shareholders have to be paid back their initial investment after a period of time

If a company liquidates, it will settle all of its liabilities, pay preferential shareholders and only then pay equity shareholders

If a company liquidates, it will settle all of its liabilities, and pay preferential shareholders before paying equity shareholders