What is preference shares?
The parts of corporate securities are called as preference shares. It is the shares, which have preferential right to get dividend and get back the initial investment at the time of winding up of the company. Preference shareholders are eligible to get fixed rate of dividend and they do not have voting rights.
Preference shares may be classified into the following major types:
1. Cumulative preference shares: Cumulative preference shares have right to claim dividends for those years which have no profits. If the company is unable to earn profit in any one or more years, C.P. Shares are unable to get any dividend but they have right to get the comparative dividend for the previous years if the company earned profit.
2. Non-cumulative preference shares: Non-cumulative preference shares have no right to enjoy the above benefits. They are eligible to get only dividend if the company earns profit during the years. Otherwise, they cannot claim any dividend.
3. Redeemable preference shares: When, the preference shares have a fixed maturity period it becomes redeemable preference shares. It can be redeemable during the lifetime of the company. The Company Act has provided certain restrictions on the return of the redeemable preference shares.
Irredeemable Preference Shares
Irredeemable preference shares can be redeemed only when the company goes for liquidator.
There is no fixed maturity period for such kind of preference shares.
Participating Preference Shares
Participating preference sharesholders have right to participate extra profits after distributing the equity shareholders.
Non-Participating Preference Shares
Non-participating preference sharesholders are not having any right to participate extra profits after distributing to the equity shareholders. Fixed rate of dividend is payable to the type of shareholders.
Convertible Preference Shares
Convertible preference sharesholders have right to convert their holding into equity shares after a specific period. The articles of association must authorize the right of conversion.
Non-convertible Preference Shares
There shares, cannot be converted into equity shares from preference shares.
Features of Preference Shares
The following are the important features of the preference shares:
1. Maturity period: Normally preference shares have no fixed maturity period except in the case of redeemable preference shares. Preference shares can be redeemable only at the time of the company liquidation.
2. Residual claims on income: Preferential sharesholders have a residual claim on income. Fixed rate of dividend is payable to the preference shareholders.
3. Residual claims on assets: The first preference is given to the preference shareholders at the time of liquidation. If any extra Assets are available that should be distributed to equity shareholder.
4. Control of Management: Preference shareholder does not have any voting rights. Hence, they cannot have control over the management of the company.
Advantages of Preference Shares
Preference shares have the following important advantages.
1. Fixed dividend: The dividend rate is fixed in the case of preference shares. It is called as fixed income security because it provides a constant rate of income to the investors.
2. Cumulative dividends: Preference shares have another advantage which is called cumulative dividends. If the company does not earn any profit in any previous years, it can be cumulative with future period dividend.
3. Redemption: Preference Shares can be redeemable after a specific period except in the case of irredeemable preference shares. There is a fixed maturity period for repayment of the initial investment.
4. Participation: Participative preference sharesholders can participate in the surplus profit after distribution to the equity shareholders.
5. Convertibility: Convertibility preference shares can be converted into equity shares when the articles of association provide such conversion.
Disadvantages of Preference Shares
1. Expensive sources of finance: Preference shares have high expensive source of finance while compared to equity shares.
2. No voting right: Generally preference shares holders do not have any voting
rights. Hence they cannot have the control over the management of the company.
3. Fixed dividend only: Preference shares can get only fixed rate of dividend. They may not enjoy more profits of the company.
4. Permanent burden: Cumulative preference shares become a permanent burden so far as the payment of dividend is concerned. Because the company must pay the dividend for the unprofitable periods also.
5. Taxation: In the taxation point of view, preference shares dividend is not a deductible expense while calculating tax. But, interest is a deductible expense.
Hence, it has disadvantage on the tax deduction point of view.