Preference Share are one type of special shares which has fixed rate of dividend and they posses special rights over equity shares in sharing of profits and also claim over assets of the firm. This is long term source of finance and neither completely similar to equity or debt. It is considered as shares but have feature of Equity and Debt. Sometime this is called “hybrid financing.”
Fixed Dividend: Commonly Debt carries a fixed interest rate, preference shares have fixed dividends attached to them.But the obligation of paying dividend is not so rigid as debt. Non- payment of dividend would not make one as bankrupt in case of preference shares.
Preference over Equity: The shareholder of preference shares will get preference over the equity shareholders in sharing the income as well as claims on assets. Preference Shares dividend have to be paid before any dividend payment to ordinary equity shares. At the time of liquidation these share would be paid before equity shares.
No Voting Rights: Normally Preference Shareholders is not entitled for any voting rights in the company’s meeting. They are considered as debenture holders and don’t have any participation in the management of the company.
No Share in Earnings: Except agreed percentage of dividend and the amount of capital invested, they are not entitled for any earnings. Equity shareholders are the entitled for the remaining earnings and residual assets in case of liquidation where preference shareholders are not entitled.
Fixed Maturity Date: Preference Shares have fixed maturity date. On the date of maturity, the preference capital will have to be repaid to the preference shareholders. Irredeemable preference shares is exception to this. They don’t have any fixed maturity.
TYPES OF PREFERENCE SHARES:
Preference shares may be classified into the following major types:
Cumulative preference shares: Cumulative preference shares have right to claim dividends for those years which have no profits. If the company is unable to earn profit in any one or more years, P. Shares are unable to get any dividend but they have right to get the comparative dividend for the previous years if the company earned profit.
Non-cumulative preference shares: Non-cumulative preference shares have no right to enjoy the above benefits. They are eligible to get only dividend if the company earns profit during the years. Otherwise, they cannot claim any dividend.
Redeemable preference shares: When, the preference shares have a fixed maturity period it becomes redeemable preference shares. It can be redeemable during the lifetime of the company. The Company Act has provided certain restrictions on the return of the redeemable preference
Irredeemable Preference Shares: Irredeemable preference shares can be redeemed only when the company goes for liquidator. There is no fixed maturity period for such kind of preference shares.
Participating Preference Shares
Participating preference sharesholders have right to participate extra profits after distributing the equity shareholders.
Non-Participating Preference Shares
Non-participating preference sharesholders are not having any right to participate extra profits after distributing to the equity shareholders. Fixed rate of dividend is payable to the type of shareholders.
Convertible Preference Shares
Convertible preference sharesholders have right to convert their holding into equity shares after a specific period. The articles of association must authorize the right of conversion.
Non-convertible Preference Shares
There shares, cannot be converted into equity shares from preference shares.
Features of Preference Shares
The following are the important features of the preference shares:
Maturity period: Normally preference shares have no fixed maturity period except in the case of redeemable preference Preference shares can be redeemable only at the time of the company liquidation.
Residual claims on income: Preferential sharesholders have a residual claim on income. Fixed rate of dividend is payable to the preference shar
Residual claims on assets: The first preference is given to the preference shareholders at the time of If any extra Assets are available that should be distributed to equity shareholder.
Control of Management: Preference shareholder does not have any voting Hence, they cannot have control over the management of the company.
Advantages of Preference Shares
Preference shares have the following important advantages.
Fixed dividend: The dividend rate is fixed in the case of preference
It is called as fixed income security because it provides a constant rate of income to the investors.
Cumulative dividends: Preference shares have another advantage which is called cumulative If the company does not earn any profit in any previous years, it can be cumulative with future period dividend.
Redemption: Preference Shares can be redeemable after a specific period except in the case of irredeemable preference There is a fixed maturity period for repayment of the initial investment.
Participation: Participative preference shareholders can participate in the surplus profit after distribution to the equity share
Convertibility: Convertibility preference shares can be converted into equity shares when the articles of association provide such conversion.
Disadvantages of Preference Shares:
Expensive sources of finance: Preference shares have high expensive source of finance while compared to equity
No voting right: Generally preference shareholders do not have any voting Hence they cannot have the control over the management of the company.
Fixed dividend only: Preference shares can get only fixed rate of They may not enjoy more profits of the company.
Permanent burden: Cumulative preference shares become a permanent burden so far as the payment of dividend is concerned. Because the company must pay the dividend for the unprofitable periods also.
Taxation: In the taxation point of view, preference shares dividend is not a deductible expense while calculating tax. But, interest is a deductible expense. Hence, it has disadvantage on the tax deduction point of view.