Home Finance SOURCE OF FINANCE FROM PREFERENCE SHARES

SOURCE OF FINANCE FROM PREFERENCE SHARES

Do you know what preference shares?

By the end of this blog, you would be able to understand about preference share with its features, types, advantages & disadvantages.

What do you mean by finance from preference shares?

The other name of preferred stock is preference share. It is also the Owner’s fund. It has a maturity period.

most importantly, the rate of dividend paid on preference shares is fixed.

Preference capital represents a hybrid form of financing possessing some characteristics of debt, such as first dividend rate, no voting right, priority over equity capital, etc.

And some characteristics of equity, such as payment of preference dividend from distributable profits, etc.

In India, the company should redeem preference shares within a maximum period of 20 years from the date of the issue as stated by the particular company.

finance pic

As the preference shareholders do not enjoy any voting right, they do not have to bear any risk and hence, it does not affect ownership.

In addition, the investors who are not willing to take any risk and are happy with the fixed lower rate of dividend like to invest in preference shares.

most importantly, these shareholders are not the real owners of the company.

moreover, Preference shareholders cannot attend the general meetings of the company and it’s issued by the company without any security.

Things that you get to know in this article:

 Preference share or preferred stock may be of different types:

different types of preference shares
  • Cumulative Preference shares:- In Cumulative Preference shares, if the dividend is not paid in a year, the arrear dividend will be accumulated and paid in the year of sufficient profit.
  • Non- Cumulative Preference shares:- In Non- Cumulative Preference shares, the arrear dividend is not accumulated and cannot be claimed by the Preference shareholders.
  • Redeemable Preference Shares:- such Preference Shares are to be redeemed on the expiry of the stipulated period, out of the proceeds of newly issued equity shares or out of profits or free reserves.
  • Non- Redeemable Preference Shares:- The preference shares are non-redeemable but it requires the company to make annual dividend payments equal to a rate of 8% on the par amount. Irredeemable preference shares are redeemed or refunded, only at the time of winding up or liquidation of the company.
  • Participating Preference Shares:- such shares enjoy a fixed rate of dividends and the shareholders also participate in the surplus of the company in a stated manner.
  • Non-Participating Preference Shares:- such shares enjoy a fixed rate of dividends and the shareholders cannot participate in the surplus of the company.
  • Convertible Preference Shares:- when Preference Shares are issued with an option for conversion into equity shares during the stipulated period of time, they are known as Convertible Preference Shares.
  • Non- Convertible Preference Shares:- when Preference Shares are issued without an option for conversion into equity shares during a stipulated period of time, they are known as Non-convertible Preference Shares.
preference share image

Why you should opt for finance from Preference shares?

From the company’s point of view:

  • Moreover, you can raise long term finance by issue of preference shares without creating any charge over the company’s assets.
  • The Issue of preference shares brings flexibility in the capital structure of the company as these are redeemed after a specific period of time.
  • The company gave the fixed financial commitment to them which can’t be affected by inflation, hence financing through these shares provides a hedge against it.
  •  most importantly, the company does not face liquidation or any legal proceedings if it fails to pay the preference dividends

From the shareholders point of view:

  • They always enjoy the preferential right in respect of payment of dividend and repayment of capital, on winding up of the company, over other classes of shares.
  • To sum up, These shares have a special appeal to investors who are not ready to take great risks and are happy with a fixed return on their investments.
  • Ordinary investors prefer to invest in preference share, as there is a guarantee of a refund of capital after a definite period.
  • certainly, As per The income tax act 1961, dividends are tax-free in the hands of the recipient.
features of preference shares

 Why you should not opt for finance from Preference shares?

From the company’s point of view: —

  • Unlike equity capital, the company cannot use preference capital permanently. It is to be repaid.
  • preference shares are to be redeemed compulsorily within 20 years, it requires a substantial cash outflow from a company.
  • The Preference dividend is not a deductible expense for taxation purposes.
  • The Non-payment of dividends may adversely affect the value of the firm.

From the shareholders point of view:–

  • As the they do not enjoy any voting right, they don’t have any voice in the management of the company.
  • The prospect of capital appreciation in preference shares is lower than the equity shares.
  • Preference shares are not easily marketable as equity shares.
  • The market prices of preference shares fluctuate much more than that of debentures.
  • Preference shareholders are to remain satisfied with a fixed rate of dividend and that too at a moderate rate. So, investment in preference shares is less attractive than investment in equity shares.

What are the features a company can enjoy by financing from Preference shares?

  • Preference shares are a part of the ownership of the company but did not have any control overpower on the affairs of the company.
  • Moreover, It also has a prior claim on the assets of the company.
  • most importantly, Preference share capital has a prior claim on income over equity capital.
  • further, Dividend at a fixed rate is payable on these shares, the rate is declared at the time of issuing such shares.
  • In addition, It represents a hybrid form of security, which satisfies some of the characteristics of equity capital. Likewise some of the characteristics of the debt capital.
  • In short, the preference dividend is an appropriation of profit, i.e. Dividend declared out of after-tax profit. Hence the full amount of dividend is the cost of preference capital. no tax benefit can be obtained for such payment.
  • Though it has the features of debt capital no collateral or Mortgage is required for obtaining capital by issuing it.

Example

Many companies offering preferred stock or preference share financing including Bank of America, Georgia Power Company, and MetLife.

preference share image

Conclusion

Preference capital represents a hybrid form of financing possessing some characteristics of debt, such as first dividend rate, no voting right, priority over equity capital, etc.

And some characteristics of equity, such as payment of preference dividend from distributable profits, etc.

In addition, Preference shares have no legal obligation to pay preference dividends.

The non-cumulative preference shares need not to pay any dividend if there is no profit.

I explained all sources of preference share finance with all of its types. I also told you the pros and cons of the respective images.

 So, guys, I hope I solved your problems regarding Preference finance.

Also read my further blogs related to finance:

PUBLIC DEPOSIT

VENTURE CAPITAL FUND

EQUITY SHARES

DEBENTURE

TERM LOAN

SOURCES OF FINANCE

BANK FINANCING

FAQ

Q. What is redeemable preference shares?

A. redeemable Preference Shares are those Preference Shares which are to be redeemed on the expiry of the stipulated period out of the proceeds of newly issued equity shares or out of profits or free reserves.

Q. why preference shares are issued?

A. when company requires long term finance and wants to pay a fixed rate then they issue preference shares or preferred stock to raise long-term finance.

Q. What are the characteristics of preference shares?

A. Preference shares financing has characteristics of debt, such as first dividend rate, no voting right, priority over equity capital, etc.

Blogger | content writer | Learner.
A commerce student from Kolkata.

BIKASH SHAW
Blogger | content writer | Learner. A commerce student from Kolkata.
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