Preference Shares: Meaning, Types & Benefits | A Complete Guide

Preference Shares: Meaning, Types, and Key Features and much more Explained

Preference shares, also known as preferred stock, are a special category of equity shares that offer investors certain advantages over common shareholders.

These shares typically come with a fixed dividend and a higher claim on company assets in case of liquidation.

Unlike common shareholders, preference shareholders usually do not have voting rights, but they enjoy priority in dividend payments.

Companies issue preference shares to attract investors who seek stable returns with lower risk compared to common shares.

Depending on their structure, preference shares can be cumulative, non-cumulative, convertible, non-convertible, redeemable, or irredeemable, each offering different benefits.

In this article, we will explore the meaning, types, key features and much more about preference shares to help you understand how they work and why they might be a suitable investment choice.

Preference Shares Meaning

Preference shares (also called preferred stock) are a type of equity security that gives shareholders certain advantages over common shareholders. These shares typically offer a fixed dividend and have a higher claim on assets and earnings than common shares, especially in case of liquidation.

Key Features of Preference Shares:

1. Fixed Dividends – Preference shareholders receive dividends at a predetermined rate before any dividends are paid to common shareholders.
2. Priority Over Common Shares – In case of company liquidation, preference shareholders are paid before common shareholders but after debt holders.
3. No Voting Rights – Generally, preference shareholders do not have voting rights in company decisions, unlike common shareholders.
4. Convertible & Redeemable Options – Some preference shares can be converted into common shares or redeemed by the company after a certain period.

Types of Preference Shares

Preference shares come in different types, each with unique features that cater to the needs of investors and companies. Here are the main types:

1. Cumulative Preference Shares

• Dividends accumulate if not paid in a given year.
• Unpaid dividends must be cleared before common shareholders receive any dividends.
• Beneficial for investors who want guaranteed returns.

✅ Example: If a company skips dividend payments for two years, it must pay those missed dividends before paying common shareholders.

2. Non-Cumulative Preference Shares

• Dividends do not accumulate if skipped.
• If the company does not declare dividends in a particular year, shareholders lose their entitlement.
• Suitable for investors willing to take some risk for potentially higher returns.

✅ Example: If the company does not make a profit, no dividend is paid, and shareholders cannot claim past unpaid dividends.

3. Participating Preference Shares

• Shareholders receive fixed dividends plus extra dividends if the company earns higher profits.
• Holders may also get a share in surplus assets if the company is liquidated.

✅ Example: If a company’s standard dividend is 8% but earns excess profits, participating shareholders might get an additional bonus dividend.

4. Non-Participating Preference Shares

• Shareholders receive only fixed dividends and do not get extra dividends, even if the company makes higher profits.
• More stable but less potential for high returns.

✅ Example: If a company issues 7% non-participating preference shares, shareholders will always receive a 7% dividend, even if the company’s profits increase.

5. Convertible Preference Shares

• Can be converted into common shares after a specific period or under certain conditions.
• Investors benefit if the company performs well, as they can switch to common shares and enjoy price appreciation.

✅ Example: A company issues convertible preference shares that can be converted into common shares at a 1:2 ratio after five years. If common share prices rise, shareholders benefit.

6. Non-Convertible Preference Shares

• Cannot be converted into common shares.
• Investors receive only fixed dividends and principal repayment if the company buys back the shares.

✅ Example: A company issues 10% non-convertible preference shares that remain preference shares forever and do not turn into common stock.

7. Redeemable Preference Shares

• The company has the right to buy back (redeem) these shares after a certain period.
• Investors get back their initial investment along with dividends.

✅ Example: A company issues 5-year redeemable preference shares, meaning investors will receive their capital back after five years.

8. Irredeemable (Perpetual) Preference Shares

• These shares cannot be redeemed and exist indefinitely.
• Shareholders receive dividends as long as the company operates.

✅ Example: Investors receive 8% dividends every year with no fixed maturity date.

Preference Shares vs. Equity Shares: Key Differences

Both preference shares and equity shares (common shares) are types of company ownership, but they differ in terms of dividends, voting rights, and risk levels. Below is a detailed comparison:

Feature	Preference Shares	Equity Shares (Common Shares)
Dividend	Fixed and paid before equity shareholders	Variable, depends on company profits
Priority in Liquidation	Higher priority than equity shares	Paid after preference shareholders
Voting Rights	Generally, no voting rights	Full voting rights in company decisions
Risk Level	Lower risk due to fixed dividends	Higher risk as dividends depend on profits
Convertibility	Can be convertible into equity shares (optional)	Cannot be converted into preference shares
Profit Sharing	Limited to fixed dividends (except for participating preference shares)	Full access to company’s profit growth
Ownership Benefits	No additional benefits beyond fixed returns	Can benefit from capital appreciation and bonuses
Redemption	Can be redeemable (bought back by the company)	Cannot be redeemed by the company

Which One is Better?

• Preference Shares are suitable for risk-averse investors who prefer stable returns.
• Equity Shares are ideal for those willing to take risks for higher returns and ownership benefits.

Purpose of Preference Shares

Preference shares serve multiple purposes for both companies and investors. Here’s why they are issued and how they benefit stakeholders:

1. For Companies (Issuers)

✅ Raising Capital Without Diluting Control

• Since preference shareholders usually don’t have voting rights, companies can raise funds without losing control to new investors.

✅ Attracting Risk-Averse Investors

• Preference shares appeal to investors seeking stable returns with lower risk compared to equity shares.

✅ Flexible Financing Option

• Unlike debt, preference shares don’t require collateral, and companies can structure them as redeemable or convertible based on financial needs.

✅ Lower Financial Burden

• Companies can issue non-cumulative preference shares, meaning they are not obligated to pay dividends if they don’t make profits.

✅ Improving Creditworthiness

• Since preference shares are equity, not debt, issuing them improves the company’s debt-to-equity ratio, making it easier to raise future loans.

2. For Investors (Shareholders)

✅ Fixed Income with Lower Risk

• Preference shares offer a fixed dividend regardless of market fluctuations, making them ideal for investors who prioritize steady income.

✅ Higher Claim on Assets

• In case of liquidation, preference shareholders are paid before equity shareholders, reducing financial risk.

✅ Convertible Option for Growth

• Some preference shares can be converted into equity shares, allowing investors to benefit from potential price appreciation.

✅ Safe Alternative to Common Shares

• Unlike common shares, preference shares are less volatile and provide a predictable return, making them suitable for conservative investors.

The primary purpose of preference shares is to help companies raise capital efficiently while offering investors a secure and fixed income source.😊

 Read More on: FAQs on LLP