Types of Preference Shares

Preference shares are shares having preferential rights with respect to dividend payments. However, these shares do not confer upon the shareholder any ownership rights. Dividends to preference shareholders are paid, before equity shareholders get paid. Usually, preference shares have a fixed rate of dividend.

Types of Preference Shares 

Preference shares are issued to raise funds without diluting voting rights. These shares are considered to be a hybrid instrument because they carry certain characteristics of debentures like assured returns.

Preference shares are usually issued to:

• Promoters of company
• Management
• Institutional lenders

The prices of ordinary or equity shares fluctuate, depending on supply and demand. Unlike equity shares, preference shares are not traded on the stock exchange. These are illiquid assets and their prices do not fluctuate like those of equity shares. Preference shares appear in the company's balance sheet under the head 'capital'.

Memorandum of Association and Articles of Association:

The rights of preference shares must be mentioned in the Memorandum of Association and Articles of Association.

• Preference shareholders cannot claim any other rights apart from those expressly mentioned in the MOA or AOA.
• Companies cannot allot preference shares if they are not mentioned in the MOA or AOA of the company.

Why do companies issue preference shares?

• Issuing equity shares would mean diluting ownership rights. Therefore, to safeguard ownership rights, companies issues preference shares.
• Companies issue preference shares because they wouldn’t want to avail loans.
• Companies issue preference shares because they give maximum flexibility, without the fear of missing interest payments. In case companies issue bonds, a missed interest payment puts the company at risk of defaulting on an issue. This results in forced bankruptcy.

Why do investors like preference shares?

• Investors like to invest in preference shares because these shares enjoy preference over equity shares, vis-a-vis dividends.
• Investors like banks and institutional investors like to invest in preference shares because they want to avoid the risk of fluctuating equity share prices.
• Preference shares are a combination of equity shares and bonds. Therefore, these are relatively stable.
• Shareholders prefer to invest in preference shares because it offers consistent dividend payments minus lengthy maturity dates like bonds.
• Preference shares are less risky when compared to equity shares.

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