PREFERENCE SHARES
- Compiled by Asst. Prof. Bhoomi Rathod
Preference Share Meaning
Preference shares, also known as preferred stock, is an exclusive share
option which enables shareholders to receive dividends announced by the
company before the equity shareholders.
Preference shares provide the shareholders with the special right to claim
dividends during the company lifetime, and also with the option to claim
repayment of capital, in case of the wind up of the company.
It is considered as a hybrid security option as it represents the
characteristics of both debt and equity investments.
The capital raised by issuing preference shares is known as preference
share capital and preference shareholders can be regarded as owners of
the company. They however do not enjoy any kind of voting rights, unlike
equity shareholders.
Preferred Stock Example
As an example, suppose that a Company ‘C’ has a total of 10,000 preference
shares to distribute among its investors. These shares are priced at ₹100
earning interest at 8% per annum. For the years of 2018 and 2019, C
company has not paid dividends to its preference shareholders.
Before the company can pay its regular shareholders in 2020, the
preference shareholders are eligible to receive ₹2,40,000 by the time 2020
rolls around. This amount is the cumulative dividend earned after 3 years
for all shareholders. Preference shareholders will get priority before other
shareholders when the company starts paying its dividends.
Features of Preference Shares
Several features of preference shares have made normal investors
superior earners even during low phases of economic growth. The
most attractive features of preference shares are given below:
They Can Be Converted Into Common Stock
Preference shares can be easily converted into common stock. If a
shareholder wants to change its holding position, they are
converted into a predetermined number of stocks.
Some preference shares inform investors that they can be
converted beyond a specific date, while others may require
permission and approval from the company’s board of directors to
be converted.
Dividend Payouts
Preference shares allow shareholders to receive dividend payouts
when other stockholders may receive dividends later or may not
be receiving dividends.
Dividend Preference
When it comes to dividends, preference shareholders have the
major advantage of receiving dividends first compared to equity
and other shareholders.
Preference In Assets
While discussing a company’s assets in the case of liquidation,
preference shareholders have priority over non-preferential
shareholders.
Types of Preference Shares
The various types of preference share are discussed below:
1. Cumulative preference share: Cumulative preference shares are a
special type of shares that entitles the shareholders to enjoy
cumulative dividend payout at times when a company is not making
profits. These dividends will be counted as arrears in years when the
company is not earning profit and will be paid on a cumulative basis,
the next year when the business generates profits.
2. Non-cumulative preference shares: These types of shares do not
accumulate dividends in the form of arrears. In the case of non-
cumulative preference shares, the dividend payout takes place from
the profits made by the company in the current year. If there is a year
in which the company doesn’t make any profit, then the shareholders
are not paid any dividends for that year and they cannot claim for
dividends in any future profit year.
3. Participating preference shares: These types of shares allow the
shareholders to demand a part in the surplus profit of the company
at the event of liquidation of the company after the dividends have
been paid to the other shareholders. In other words, these
shareholders enjoy fixed dividends and also share a part of the
surplus profit of the company along with equity shareholders.
4. Non-participating preference shares: These shares do not yield the
shareholders the additional option of earning dividends from the
surplus profits earned by the company. In this case, the shareholders
receive only the fixed dividend.
5. Redeemable Preference Shares: Redeemable preference shares are
shares that can be repurchased or redeemed by the issuing company
at a fixed rate and date. These types of shares help the company by
providing a cushion during times of inflation.
6. Non-redeemable Preference Shares: Non-redeemable preference
shares are those shares that cannot be redeemed during the entire
lifetime of the company. In other words, these shares can only be
redeemed at the time of winding up of the company.
7. Convertible Preference Shares: Convertible preference shares are a
type of shares that enables the shareholders to convert their
preference shares into equity shares at a fixed rate, after the expiry of
a specified period as mentioned in the memorandum.
8. Non-convertible Preference Shares: These type of preference
shares cannot be converted into equity shares. These shares will only
get fixed dividend payout and also enjoy preferential dividend payout
during the dissolution of a company.
Difference between preference shares and equity shares
When you start your investment journey it is important to understand
various investment options to have a smooth investment journey. Although
equity shares and preference shares are similar but not the same. So, let's
understand the difference between these two shares.
Equity shareholders have voting rights in the company however,
preference shareholders are not entitled to voting rights in the
company and as equity shareholders have voting rights, they take
part in the company's management.
When a company distributes its dividends or payback capital during
the liquidation of the company, preference shareholders enjoy first
preference over equity shareholders.
The rate of dividend is fixed for preference shares while the rate of
dividend fluctuates for equity shares with more earnings as the
company is under no obligation to pay dividends to its equity
shareholders.
Preference shares can be converted whenever a shareholder wishes
to but equity shares can not be convertible.
Preference shares represent the preferential rights to the company’s
earnings and assets while equity shares represent owning a part of
ownership in a company.
Preference shareholders are not entitled to receive any bonus against
their holdings while equity shareholders are entitled to receive
bonus shares against their holdings.
Preference shares are redeemable while equity shares are not
redeemable.
Specific types of preference shareholders are qualified for arrears of
dividends while equity shareholders do not get any arrears of
dividends.
-Trading in Exchanges and Liquidity
Equity shares in India trade on exchanges such as the Bombay Stock
Exchange or the National Stock Exchange. Any retail investor with a Demat
account can purchase equity shares. This makes equity shares highly liquid.
On the other hand, preference shares do not trade on exchanges. These
shares trade in the Over the Counter (OTC) market, where shares trade
informally. As a result, preference shares are relatively less liquid.
-Redemption versus Share Repurchases
There is a specific type of preferred shares known as ‘Redeemable
Preference Shares’. These shares are redeemed or repaid after a certain
time period. Shareholders must sell the stock upon redemption.
In share buybacks, the company buys back its shares at the current market
price. This is a popular way of returning cash to equity stockholders.
However, share buybacks are entirely voluntary, and shareholders can
choose not to sell their shares.
-Bonus Shares/Rights Issue
Companies may issue bonus shares to equity shareholders. Typically,
companies issue bonus shares to reduce their share price and increase
their investor base by improving their affordability. Equity shares can also
participate in a rights issue when a company allows its existing
shareholders to buy its shares at a lower price. Preference shares do not
get bonus shares. Also, they do not get the rights to buy equity shares if the
company is giving a rights issue.
-Face Value
Most equity shares in India have a face value of INR 10. On the other hand,
preference shares have a higher face value of INR 100 or INR 1,000. Note
that the face value is different from the market value of the company. Due
to their higher face value (e.g., INR 1,000), preference shares can be
unaffordable to small-scale investors.
Every public company listed on leading stock exchanges has issued equity
shares. Preference shares are relatively rare. In the recent past, companies
like Tata Capital and IL&FS have issued preference shares.
The differences between equity share and preference share are
summarised below:
Characteristic Equity Shares Preference Shares
Dividend payments Not fixed Fixed
Order in claim on
Lower Higher
assets
Voting rights On all key decisions Only on selective decisions
Convertible/Non-
convertible
Ordinary equity shares
Cumulative/Non-
Differential Voting
Variety/types cumulative
Rights (DVRs)
Participatory/Non-
participatory
Trade on exchanges like
Trade in the OTC market
the BSE and the NSE
Trading on exchanges Less liquid
Highly liquid
Buyback options for Possible under share Possible for redeemable
the company buybacks preference shares
Rights for No voting rights, but several
Voting rights
shareholders other rights
INR 10 per share in most
Face value INR 100 or INR 1,000 per share
cases
Attractive to investors willing Attractive to risk-averse
Types of investors
to take risks investors
Similarities between preference shares and equity shares
Both equity and preference share own capital of the company.
Both equity and permanent shares are raised by public companies.
Both equity and preference shares come under section 85 of the
Indian Companies Act 1956.
How to Issue Preference Shares?
Preference shares are a class of shares of a company that entitles the
shareholder to fixed dividends on preference over ordinary shares.
A private limited company or limited company in India can issue
preference shares, subject to approval by the articles of association of the
company and the Board of Directors. In this article, we look at the
procedure for issuing preference shares.
Key Aspects
Ensure the company is limited by shares.
Ensure the Articles of Association of the company permits issue of
preference shares.
Preference shares must be redeemed within a period of 20 years
from the date of issue. Only companies involved in infrastructure
projects can issue preference shares redeemable over 20 years from
date of issue.
Step 1: Call Board Meeting
Call a Board Meeting by giving not less than 7 days of notice to every
director of the company. Decide on the date, time, place and agenda for
calling a General Meeting to pass a special resolution for issuing preference
shares.
Step 2: Draft a Board Resolution
Prepare a board resolution for issue of preference shares. The board
resolution must address aspects such as:
Priority with respect to payment of dividends and capital
Participation in surplus funds
Participation in surplus assets and profits, on winding up of company
Payment of dividend – cumulative or non-cumulative basis.
Conversion of preference shares in equity shares.
Voting rights
Redemption of preference shares.
Step 3: Draft Explanatory Statement to Board Resolution
Prepare an explanatory statement to the Board Resolution with all the facts
pertaining to the proposed issue of preference shares. The explanatory
statement must include information such as:
Size, number of preference shares to be issued and value of each
share.
Nature of shares to be issued, cumulative or non-cumulative,
participating or non-participating, convertible or non-convertible.
Objectives of the issue.
Manner of issue of shares.
Price at which shares are to be issue.
Basis on which price was calculated.
Terms of issue, including terms and rate of dividend (coupon rate) on
each share.
Terms of redemption, including tenure of redemption, redemption of
shares at premium and terms of conversion, if applicable.
Manner and modes of redemption.
Current shareholding pattern of the company.
Expected dilution in equity on conversion, if applicable.
Step 4: Conduct Board Meeting
Conduct a General Meeting as per the notice to board meeting and pass the
special resolution.
Step 5: File MGT-14
File the special resolution approved in the Board Meeting with the ROC
using Form MGT-14 within 30 days. MGT-14 must contain a copy of the
approved special resolution and the explanatory statement. The form must
be digitally signed by managing director or director or secretary of the
company authorised by the Board. In addition, the form must also be
digitally signed and certified by a Chartered Accountant or Cost Accountant
or Company Secretary in whole-time practice.
The maximum period for which the company can issue the preference
should not exceed twenty years. That is such shares must be redeemed
within that period.
The redemption of preference shares implies the repayment to the
shareholders either at a fixed date or within a time frame. Preference
shares can be redeemed only if it is fully paid-up. The shares are redeemed
out of the profits that are available for distribution to its shareholders or
from the fresh proceeds issued for funding the redemption of preference
shares.
Accounting for Preference Shares
In a financial statement of a company, redeemable preference shares are
reported as a liability. The dividend paid on such shares is recorded as an
expense in the income statement.
Parameter of
Private Placement Preferential Allotment
Comparison
Meaning The offering of securities by Issuing of share and other
a company to a given group company securities to a
of specific investors person and is mainly based on
a preferential basis.
Minimum Has a minimum Has no minimum subscription
Subscription Fee subscription fee fee
Article Authorization No authorization in AOA- Requires Authorization in AOA
Article of Authorization
Bank Account Maintaining of a separate Has no requirement for
Required bank account for the maintain a different bank
keeping of the application account
money
Valuation Report Needs a valuation report No valuation report is
Required required
Allotment Period Has an allotment period of Has a 12-month period from
Parameter of
Private Placement Preferential Allotment
Comparison
60 days from the period of the date of passing of the
payment of the application special resolution
money date
Listed companies have a 15
day period from the passing o
a special resolution.
Offer Letter Private Placement offer Has no such Documentation
letter should be available
Payment of Payment is by Cheque, Cash payment can be issued or
Consideration demand draft of by way of other consideration other than
other approved banking cash
channels
PRIVATE PLACEMENT
his is the offering of securities by a company to a given group of investors
with the aim of raising finances. It is mainly used to avoid the IPO
processes which are way time consuming and very costly.
This allows for the selling of securities privately. In a financial year, the
private placement can be made up of up to 200 persons or less this is
without the inclusion of qualified Institution players or security that is
offered to company employees by way of ESOP.
If issuing the private placement shares is more than the
predetermined number of 200 individuals, then it becomes a public
issue making the company become regulated accordingly. Allotment
of securities is to be made to the investors within 60 days from the date
of receipt issue or else a refund of 15 days must be made to the investors.
A defaulting company in returning the investor money with 15 days has a
liability of paying back the entire sum of money with interest of 12%
from the 60th day. There are two types of private placements, they
include qualified institutional placement and preferential allotment.
PREFERENTIAL ALLOTMENT
This is the giving out of shares or issuing out of shares or company
securities to a selected person based on a preferential basis. For a
preferential allotment to happen, regulations must be complied
with.
1. Company articles of association must be authorized.
2. A special resolution is to be approved by the central government
for it to take place.
3. Full payment should be given when the issuing of the securities
This helps in saving cost that is involved in the public issue of the
securities. It is also a faster way of a company to raise capital through the
issuing of share in bulk.
It may be used as a way of helping out a company that is trouble through
some injection of capital in order to move the company out of a bad
situation.
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