Are you an investor in the share market? If you are – you know that the share market consists of a variety of stocks as a whole. If you are just entering the share market, you would have to know that there is a whole variety of things that you would have to select from.
This also means that you would have to know each of these shares in detail and for good in the market. Only when you do would you know the effects that it would have on your investment portfolio.
First things first – let’s know our basics.
What are Preference Shares?
Preference shares, as the name implies, give their holders preferential consideration when it comes to collecting dividends and revenue sharing.
When a corporation declares dividends, preference shareholders have precedence over regular stock shareholders. Even if a corporation goes bankrupt, preference shareholders are paid first, followed by common equity owners.
Despite their numerous advantages, preference shares are not as popular as common equity shares. One big reason for this is that the majority of investors may not even understand what preference shares are!
We would answer any of your queries about preference shares in this article. We will also go over the benefits and drawbacks of preference shares.
Advantages of Preference Shares
1) There are no legality issues –
There is no obligation to pay preferred dividends because failure to do so does not result in bankruptcy. This dividend is not a fixed liability, such as loan interest, which must be paid in all circumstances.
2) Control is never diluted –
The issuance of preference shares has no effect on current equity shareholders’ control. Because there is no link between voting rights and the issuance of preferred share capital. Preference shareholders invest their cash with a fixed dividend percentage but do not have control rights.
3) Grows the borrowing capacity –
Preference shares become part of the net value, lowering the debt-to-equity ratio. This is how the company’s entire borrowing capacity grows.
4) There are no charges on the assets –
When taking out a term loan, the financial institution must be given security in the form of main and collateral security. There are no such requirements. Therefore the corporation receives the necessary funds while the assets stay free of charge, that is, even if you are investing in stock from NIFTY PSU Bank.
Disadvantages of Preference Shares
1) There is a fixed obligation –
The dividend on preference shares needs to be paid at a specified rate before the dividend on equity shares is paid. The burden is higher in the case of cumulative preference shares, on which accumulated dividend arrears must be paid.
2) There are lower returns –
When the company’s earnings are large, a fixed dividend on preference shares becomes unappealing. Preference shareholders often do not have the right to share in the company’s success.
3) There is a limited appeal –
Preference shares are disliked by daring investors. Debentures and government securities are preferred by cautious and conservative investors. To attract enough investors, a corporation may have to offer a higher dividend rate on preference shares.
4) There is the Fear of Redemption –
Holders of redeemable preference shares may have contributed monies when the company was in desperate need of funds. However, if the money market is favorable, the corporation may repay its money. Despite the fact that they helped the company in its hour of need, they are fired without explanation.
5) There are no voting rights –
Preference shares do not typically have voting rights. As a result, preference shareholders are powerless and have no say in the company’s management and control.
6) Claim preference –
Priority shareholders have the same rights as equity shareholders, but they have a preference in both the payment of their fixed dividend and the claim on assets in the event of liquidation.
Issuing a Preference Share
The corporation must guarantee that issuing preference shares is authorized by the company’s Articles of Association (AOA). Later in an Annual General Meeting (AGM), the relevant information is reviewed with the use of an explanatory statement, such as:
- The size of the issuance, the number of preferred shares, and the nominal value of the shares
- The characteristics of the shares
- The problem’s goal.
- Issue terms, dividend rate, and redemption period
- The company’s current shareholding pattern.
- Expected equity share dilution upon conversion (in case the nature of shares is convertible.)
- Following the adoption of the resolution, the firm must file a statement with the Registrars of Companies (ROC) within 30 days.
How is a Preference Share Similar to a Debenture?
- Except for participating preference shares, all preference shares and debentures have a fixed dividend or interest rate determined at the time of issue and cannot receive any part of the company’s profits after that.
- Neither has the right to vote.
- Both have a set rate of return.
- Ordinary shareholders are the only ones who can vote.
- Both are entitled to the company’s income and assets before ordinary shareholders.
- Debenture holders, on the other hand, take precedence over preference stockholders.
- Both are frequently redeemable.
- Both have the right of return cumulatively.
How is a Preference Share Different from a Debenture?
- The corporation is owned by preference shareholders, while debt holders are creditors.
- Preference shareholders receive a dividend based on the availability of profits, whereas debenture holders receive interest that is payable regardless of the company’s profit or loss.
- Debenture holders’ claims on the company’s assets take precedence over preference shareholders.
- Debentures are often redeemable, whereas preference shares are irredeemable.
- Certain preference shares may benefit over their guaranteed minimum, whereas debenture holders can never expect to earn more than the specified interest rate.
Final Thoughts
Now that you know about the preference shares and the pros and cons associated with them, it will become easier for you to know if this kind of share is a suitable investment opportunity for you.