Companies release preference shares or preferred stocks to raise capital. They are also known as preference share capital. If any company is facing losses or is winding up, the last payments are made to the preference shareholders before the equity shareholders.
Preference shares enable shareholders to receive the dividends announced by the company. Preferred stocks shareholders always receive dividends before equity shareholders. If a company pays out a dividend to its investors, the preferred shareholders receive the first payout.
The unique characteristics of preference shares have turned ordinary investors into expert investors even during bad phases of economic growth. Some features of preference shares are explained below:
It is easy to convert preference shares into common stock. A shareholder willing to change its holding position can get it converted to a predetermined number of preference shares. In some types of preference shares, investors are provided with a specific date to convert their shares. In other types, shareholders might require permission from the company’s board.
Shareholders with preference shares receive dividend payouts, while other shareholders might receive it later. Sometimes, the other shareholders do not receive the payout.
Regarding dividends, preference shareholders receive dividends before equity or other shareholders.
Preference shareholders have the right to vote in case of any extraordinary events. But this is occasional. With preference shares, shareholders do not have voting rights in matters of the company’s management.
In the case of the company’s liquidation, the preferred shareholders are prioritised over non-preferential shareholders on its assets.
The varied types of preference shares have been enumerated below:
Preferred Shareholders enjoy the following benefits:
Some of the significant differences between preference shares and equity shares are explained below:
S.No | Category | Preference Shares | Equity Shares |
|
Voting Rights | In case of an extraordinary situation. Otherwise does not have any voting rights. | Common equity has got voting rights. |
|
Payments | Preferred equity holders receive dividends, both cumulative and non-cumulative. | Common shareholders are not entitled to fixed dividends. They may or may not receive dividends. |
|
Volatility | Preferred shares have got steady price movements. | Common shares react actively to the developments of the market. |
Preference stocks are classified as equity. It is similar to the general equity offered by a company. Preference shares are paid dividends from the profit after the tax, whereas preference shares have a fixed dividend rate.
The differences between preference shares and bonds have been discussed below:
S.No | Category | Preference Shares | Bond |
|
Classification | Preference shares as equity. | Bonds have been classified as debt. |
|
Dividend Payments | The dividend amounts are fixed but not guaranteed. | The interest on the bonds must be made as per schedule. |
|
Tradability | Preference shares are more of liquid nature as they trade on the stock exchange. | Bonds are over-the-market securities that have a negligible presence on the exchange. |
In previous years, several reputed companies, such as IL&FS Transportation networks, Tata Capital, and many more, have issued preference shares under private placement. The dividend rates of these preferred stocks are lucrative and tax-free, up to Rs. 10 lakh.
Preference shares have their risks and potential. Investors must study the company’s performance and growth potential. It would be wise to analyse its fundamentals and management before investing in preference shares. Yes, it is too much work. With TradeSmart, you will get instant ratings with all the company details listed on the stock exchange.
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The key disadvantage in preference shares is that the investors do not have voting rights as compared to equity shareholders. Hence, it specifies that the company is not answerable to the preferred shareholders the way it is to the equity shareholders.
After a specific time, a preference shareholder can sell the preference shares back to the company. This is not applicable in the case of ordinary shares. Equity investors need to sell the shares to other buyers in the market. Investors can sell their shares back only if it announces a buyback offer.
Companies primarily issue preference shares to raise fresh capital. They also issue preferred stocks in the following situations:
Preferred stocks that can be easily converted into equity shares are also known as convertible preference shares. Some preference shares also receive arrears for the dividends known as cumulative preference shares.
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