Everyone wants to have a different source of income in their life. And for that, some will start investing their actively earned income to make a good amount of passive income. We, as an investor, invest our money to maximize the return and grow the wealth. But there is more than one way to achieve it. Different instruments are available in the market to raise your money. Each agency has its specialty; some will help you grow your money quickly, while others will take time to develop.
In The earlier Article, we Learned About Equity Shares Now In This Article, We Will Learn About What is Preference shares, What Is Features and What Are The Types of Preference Shares.
Preference Share:
Preference shares or preferred stock represent ownership in a company. Preference shareholders enjoy preference over ordinary shareholders on assets and earnings. Also, in case of bankruptcy, preferred shareholders want the priority to receive the company’s assets before common shareholders.
A company issues preference shares to raise capital. This becomes part of the preference share capital. Preference shareholders receive dividends before the equity shareholders. A specific type of preference share is eligible to receive arrears of gratuities. Furthermore, you can easily convert these shares to equity shares.
Also, in India, you can redeem preferred shares within 20 years of their issuance. Such share is redeemable preference shares. On the other hand, the Companies Act 2013 doesn’t allow companies to issue irredeemable preference stocks in India.
Though preference shareholders have the right to company earnings first, they do not have voting rights like the equity shareholders.
Many long-term investors seeking regular income prefer these shares, as the dividends are higher than what an equity shareholder gets.
Features of Preference Shares
- Preference Shareholders have the first right to claim the company’s assets whenever they decide to wind up their operations.
- Preference Shareholders have the first claim to their dividend.
- The Preference Shareholders get a fixed rate of dividend.
- Preference shareholders do not get voting rights in the selection of the company’s management.
- Preference Shares have features of both debt and equity investment. They are also known as a hybrid security option for their investors.
Types Of Preference Shares
1)Cumulative preference shares–
Cumulative shares permit investors to receive dividends in arrears. In other words, sometimes, a company’s financial position prevents it from paying dividends to its stockholders. Dividends cannot be paid to common shareholders unless preference stockholders are paid. Under such circumstances, the corporation will pay cumulative dividends the following year. The cumulative preferred stockholders are sometimes granted interest earned by stockholders on arrear dividends.
2)Non-Cumulative Preference Shares-
Non-cumulative preference shareholders are not eligible to receive dividends in arrears. They are only eligible for dividends from the current year’s profit. In other words, if a company doesn’t make profits or decides not to pay dividends in a year, these shareholders cannot claim unpaid dividends in the future. So, the shareholders will not receive any dividends for that year.
3)Redeemable preference share–
Redeemable shares give the company the right to buy back the share from the shareholders on a set date or by giving prior notice. The company can buy back the share for its use. The price of the such repurchase is prefixed.
4)Irredeemable preference share-
The company can only redeem irredeemable shares during liquidation or when it winds up its operations.
5)Convertible preference share-
When preference shares can be converted into equity at a fixed rate, it is known as Convertible preference shares.
6)Non-Convertible share-
Non-convertible preference shareholders have no such right to convert to equity stocks. Shares that cannot be converted into equity shares are known as Non-Convertible shares.
7)Participating preference shares-
Participating preference shareholders receive an additional dividend other than the preference dividend. In other words, the company pays an extra dividend to the participating shareholders. The additional rate is usually fixed. Furthermore, these shareholders have rights over the company’s surplus assets when it is winding down or liquidating.
8)Non-participating preference share-
Non-participating preference shareholders only enjoy dividends at a fixed rate and are not eligible for surplus profits. The common stockholders enjoy the additional profits.
9)Adjustable Preference Shares-
For adjustable preference shareholders, the dividend rates are dynamic. The rate depends on the prevailing interest rates in the market. Hence, the dividend rates are volatile.
Advantages of Preference Shares
Always Convertible for Common Stock-
It is easy to convert preference shares into common stock. The shareholder may exchange their shares for a specified number of preference stocks if they want. When investors purchase preferred shares, they are typically informed that the claims can be converted into common stock at a future date. In some instances, however, the conversion of preference stocks may be contingent on the board of directors’ approval.
Preferred Dividends-
As opposed to equity and other shareholders, preference shareholders typically receive dividends before other shareholders. Current legislation stipulates that preferred stockholders receive dividends before common stockholders.
When obtaining what was promised, preferred shareholders fare better than regular stockholders. However, preferred shareholders typically have no say in the company’s daily operations.
Dividend Payouts-
Even if the corporation decides not to pay dividends to other stockholders or pays them later, investors who possess preference shares are entitled to dividend payments. The method through which a company determines how much of its profits to distribute to shareholders is referred to as its dividend distribution policy.
The dividend payout policy of a corporation is determined by factors such as the proportion of dividends paid out relative to total payouts and the timing of dividend payments.
The Right to Vote is a Privilege-
If there is an additional shareholder meeting, preference shareholders will have the opportunity to vote. On the other hand, this is extremely uncommon and only occurs in a few instances. When you purchase stock in a corporation, you often have no say in its management.
A Choice that Benefits the Assets-
When a corporation ceases operations and must be liquidate, preference shareholders are compensate before common shareholders. Those who own preferred stock are entitled to a larger portion of the company’s assets in the event of liquidation than those who own regular stock. When the market has the appropriate number of shares, shareholders will receive dividend payments.
Disadvantages of Preference Shares
Fixed Obligation–
Dividends on preference shares must be paid at a fixed rate before any dividend is paid on equity shares. The burden is greater in the case of cumulative preference shares on which accumulated arrears of dividends have to be paid.
Limited Appeal–
Bold investors do not like preference shares. Cautious and conservative investors prefer debentures and government securities. A company may have to offer a higher dividend rate on preference shares to attract sufficient investors.
Low Return–
When the company’s earnings are high, fixed dividend on preference shares becomes unattractive. Preference shareholders generally do not have the right to participate in the company’s prosperity.
No Voting Rights–
Preference shares generally do not carry voting rights. As a result, preference shareholders are helpless and have no say in the management and control of the company.
Fear of Redemption–
The holders of redeemable preference shares might have contributed finance when the company badly needed funds. But the company may refund their money whenever the money market is favorable. Even though they stood by the company in its hour of need, they are shown the door unceremoniously.
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