Preference shares, also called preferred stocks, enable preference shareholders to receive dividends announced by companies before ordinary shareholders. For instance, if companies decide to pay dividends to their shareholders, preference shareholders are the first to receive dividend payouts from the company.
Indian firms issue two types of shares, called equity shares and preference shares, according to the Companies Act, 2013. Moreover, if a company winds up, the final payment is first made to preference shareholders and then to the ordinary shareholders. Preference shares must be redeemed within 20 years of their issuance and are called redeemable preference shares. Indian companies cannot issue irredeemable preference shares according to the Companies Act, 2013.
It is a common type of preference share where shareholders are entitled to receive dividends for a year where dividends could not be paid as the company had inadequate profits. For example, suppose a company doesn’t have sufficient profits in a particular year to pay out dividends.
In that case, it pays cumulative dividends in the following year as arrears if it makes adequate profits. In simple terms, cumulative preference shareholders enjoy the right to dividends even in the years in which the company does not make profits.
Non-cumulative preference shareholders are not entitled to dividends for a year where the company could not pay dividends due to losses or insufficient profits.
For example, if a company announces dividends and skips the dividend payments, it is under no obligation to stick to the earlier announcement of paying out dividends. In the case of non-cumulative preference shares, the right to dividends for a particular year cannot be carried forward to the subsequent years.
Companies issuing redeemable preference shares redeem them at a later stage. Moreover, companies must redeem these preference shares within 20 days from the issue date. These shares are also known as callable preference shares.
Irredeemable preference shares can be redeemed by a company only on liquidation or shutting down of operations. However, Indian companies cannot issue irredeemable preference shares.
Convertible Preference shares are converted into common equity shares of the company at a specific price and time, depending on the terms and conditions of the issue. It is the most versatile form of preferred equity. Shareholders earn a fixed return through dividends and the possibility of higher returns if the company’s share price rises.
Non-Convertible Preference Shares cannot be converted into ordinary equity shares of the company. However, they still retain preferential rights towards the payment of capital over common shareholders in case of the winding-up of the company.
Participating Preference Shareholders stand a chance of earning more than the stated rate of fixed dividends. These shareholders earn higher dividends if the company makes surplus profits above the stated earnings benchmark.
Participating Preference Shareholders earn fixed dividends and the opportunity to share in the company’s extra earnings or profits. You can invest in participating preference shares of companies that are likely to have robust revenues and profit.
Non-Participating Preference Shareholders are entitled to pre-fixed dividend payments. They cannot participate in the surplus profits of the company.
Adjustable preference shareholders do not qualify for a fixed dividend rate under adjustable preference shares. The dividends payouts depend on the interest rates prevalent in the market.
The company issuing callable preference shares has the right to buy back or call in the shares at a specific price on a certain date. The company prospectus specifies the call price of the shares, the date on which the shares can be called and the call premium.
Equity shareholders enjoy voting rights in the company. However, preference shareholders have ownership in the company just like equity shareholders but do not have voting rights.
Preference shareholders enjoy preference over equity shareholders when it comes to the distribution of dividends at a fixed rate and the payback of capital in case of liquidation of the company.
Another significant difference between preference shares and equity shares is that preference share dividend is cumulative. However, the equity share dividend is not cumulative even if it is not paid out for several years. Moreover, preference shares can be redeemed, but you cannot redeem equity shares.
As equity shareholders have voting rights, they can participate in the company’s management. However, preference shareholders cannot participate in the company management as they don’t have voting rights. Moreover, every company doesn’t need to issue preference shares, but all companies must compulsorily issue equity shares.