What are Preference Shares

Published on: Tue Jun 06 2023

Introduction:

In the realm of investments and finance, shares play a pivotal role. Shares are essentially units of ownership in a company, granting shareholders certain rights and entitlements. Among the various types of shares, preference shares hold a significant position. In this blog post, we will delve into the world of preference shares, exploring their definition, types, examples, and key aspects specifically within the Indian context.

Types of Shares in India:

Before we delve into preference shares, it is crucial to understand the different types of shares available in India. In India, shares are primarily classified into two categories: equity shares and preference shares. Equity shares, also known as ordinary shares, are the most common form of shares. They represent ownership in a company and offer voting rights in proportion to the number of shares held. On the other hand, preference shares are a distinct class of shares that confer certain preferential rights to the shareholders.

Understanding Preference Shares:

Preference shares are a hybrid form of capital that lies between equity and debt. These shares combine features of both equity and debt instruments. They offer shareholders preferential treatment over equity shareholders but do not grant voting rights. Preference shares provide a fixed rate of dividend payment to shareholders before any dividend is distributed to equity shareholders.

Types of Preference Shares:

In India, preference shares can be further categorized into several types, including:

Cumulative Preference Shares: These shares carry a right to receive dividends even in case of a profitless year. Any unpaid dividends accumulate and are paid in future years when the company makes profits.

Non-cumulative Preference Shares: Unlike cumulative preference shares, non-cumulative preference shares do not carry the right to accumulate unpaid dividends. If the company fails to pay dividends in a particular year, the shareholders forgo their entitlement.

Redeemable Preference Shares: Redeemable preference shares are issued with a predetermined date or event upon which the company will redeem the shares and pay back the capital amount to the shareholders.

Convertible Preference Shares: Convertible preference shares provide an option for the shareholder to convert their preference shares into equity shares after a specified period. This conversion allows the shareholder to participate in the company's future growth and enjoy the voting rights associated with equity shares.

Participating Preference Shares: Participating preference shares offer additional benefits to shareholders. These shares entitle the holder to receive dividends beyond the fixed dividend rate when the company achieves a certain level of profit. This allows shareholders to participate in the company's success.

Examples of Preference Shares in India:

Several Indian companies have issued preference shares to raise capital and provide investors with varying preferences. Some prominent examples of preference shares in India include:

Tata Motors: Tata Motors issued non-cumulative preference shares with a fixed dividend rate of 9%. These shares do not carry voting rights but provide a higher priority in dividend distribution compared to equity shareholders.

Reliance Industries Limited: Reliance Industries issued convertible preference shares to institutional investors. These shares provide an opportunity for the investors to convert their preference shares into equity shares at a predetermined price.

Key Aspects of Preference Shares:

While considering preference shares, it is important to consider a few key aspects:

Dividend Priority: Preference shareholders have a higher priority in receiving dividends compared to equity shareholders. The fixed dividend rate ensures a consistent income stream.

Voting Rights: Unlike equity shareholders, preference shareholders do not typically possess voting rights in the company's decision-making processes.

Capital Protection: Preference shareholders enjoy a higher level of capital protection since they are entitled to receive their invested capital before equity shareholders in the event of liquidation.

Limited Upside Potential: Although preference shareholders receive fixed dividends, they have limited upside potential compared to equity shareholders. They do not participate in the company's growth beyond the fixed dividend rate.

Preference shares occupy a unique position in the investment landscape of India. They offer investors an opportunity to receive fixed dividends and enjoy certain preferential treatment over equity shareholders. By understanding the types, examples, and key aspects of preference shares, investors can make informed decisions while diversifying their investment portfolios. Whether considering cumulative or non-cumulative preference shares, redeemable or convertible preference shares, it is crucial to evaluate the specific terms and conditions associated with each investment opportunity.

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