Preference shares constitute part of share capital and it is long term source of finance for the company preference shares are those type of shares which have preferential rights over dividends as well capital in case of liquidation of the company. In real life, people drink warm water because some people cannot drink too cold or too hot water and for them, warm water is ideal, in the case of finance equity shares and debentures are like hot and cold water respectively and debenture is like warm water. In order to understand more about preference shares let’s look at some of the features of preference shares –
- The first and foremost feature of preference share is that person or individual holding preference shares are called preference shareholders of the company and preference shareholders are not the owners of the company.
- Another feature of preference share is that they get dividend before the equity shareholders and the rate of dividend is also fixed and does not change unlike equity shares, so for example if the company has earned net profit of $100000 and dividend rate on preference shares is 10 percent and there are 10000 preference shareholders having face value of $100 then each preference shareholder will get $10 as dividend and there will nothing left for equity shareholders. Hence preference shareholders are paid dividend first and then if anything is left then dividend to equity shareholders is paid.
- Preference shares have no voting rights and hence they are not entitled to vote on important matters of the company like the selection of directors or chairman, merger and acquisition related decision, bonus and right issue decision and so on. Hence any company which does not want to dilute their holding or voting rights prefer to issue preference shares.
- In the event of winding up of the company with regards to capital repayment, first debenture holders are paid and then preference holders are paid and then lastly equity holders are paid. Hence preference shares are in the middle as far as capital repayment in case of winding up of the company is concerned.
- Preference shares are of many types like cumulative shares in which if the company is not able to pay dividend in current year then it will accumulate and company will to have pay those unpaid dividends in future whereas in case of non-cumulative dividends do not accumulate, convertible shares which give shareholders the right to convert their preference shares into equity shares after a fixed period of time or non-convertible preference which carry no conversion rights and so on.
- Another feature of preference share is that as far company is concerned it is long term source of finance for the company because the repayment date of preference share capital is fixed and they are usually repaid after 5 years or more and hence company know the exact date and amount to be repaid by the company to the preference shareholders.
As one can see from the above preference shares have many unique characteristics and it is somewhere in between of high-risk equity shares and low-risk debentures and hence it is ideal for those who people who do not want too much risk and constant return on their capital.