BAJAJ BROKING
June 03, 2023
4 mins read
Preference shares are typically stock option that allows shareholders to receive dividends before the equity shareholders. However, preference shares are not allotted to the general public.
Preference shares provide both the investor and the business with numerous advantages. For the investor, preference shares provide a fixed income and are often less risky than other investments. For the company, preference shares offer a way to raise capital without taking on debt.
This article will explain the meaning of preference shares.
Preference shares meaning is that it is a type of equity share that provides certain preferential rights to the shareholders, in terms of dividends and assets, compared to the ordinary shareholders.
The advantages of preference shares are that it offers preferential rights, including the right to a fixed rate of dividend payment before any dividend payment to regular shareholders and the right to the firm’s assets in the case of bankruptcy after the creditors.
However, it does not come with voting rights like common equity shareholders.
Preference shares blend traits of equity and debt instruments while offering investors specific preferential rights like fixed dividends, priority in asset claims, and variations based on conversion or call options.
Dividends are paid to preference shareholders first, typically at a fixed rate, before being distributed to equity holders. Missed dividends mount up and need to be paid later under cumulative preference shares. Unpaid dividends are forfeited for non-cumulative types of shares.
Preference shareholders typically retain management control alongside equity shareholders by refraining from voting on routine decisions. They might, however, be granted the ability to vote in specific situations, such as when dividends are past due.
Preference shares offer a steady income stream that is similar to fixed-income securities in that dividends are fixed and paid on prearranged dates. Investors who are risk-averse are drawn to this stability.
Some preference shares may be redeemable, callable, convertible, or adjustable-rate, offering investors options like exit date certainty, interest-rate protection, or eventual equity participation.
Some attributes of preference share capital include:
Let's take a quick look at the types of preference shares.
With cumulative preference shares, shareholders can receive dividends for every year in which they could not do so owing to a lack of adequate profits. For instance, if a corporation does not generate enough profit in a given year, it will not distribute any dividends in that year but instead, pay arrears on cumulative dividends in the next year.
These shares do not build up arrears of dividend payments. Non-cumulative preference shares receive dividends from the company’s profits only for the current year. The stockholders are not paid any dividends during a year in which the business is not profitable, and they are also ineligible to receive dividends in any subsequent profitable years.
Shares that can be redeemed by the issuing business within 20 days of the issuance date to meet their objectives are redeemable preference shares.
These are not redeemable at any point throughout the company’s existence and are known as non-redeemable preference shares. These shares can only be redeemed when the firm is wound up.
Convertible preference shares allow owners to convert their preference shares into equity shares at a predetermined rate following the expiration of a defined period as stipulated in the memorandum.
Shares that cannot be converted into common shares are known as non-convertible shares. However, they still do have preference rights when it comes to capital payments if the company is wound up.
These shareholders have the right to receive a part of the surplus profit if the company files for bankruptcy. The profit will only be received after paying the dividends to other shareholders.
In non-participating preference shares, shareholders are not entitled to extra profits in the event of liquidation.
Following a predetermined date and at a predetermined price, the issuing company may repurchase these shares. Higher dividend rates are generally paid to investors, but they also run the risk of being redeemed early if market rates decline.
In this case, dividend rates fluctuate according to benchmarks of market interest. Dividends increase in tandem with interest rates, assisting investors in maintaining return value in relation to the state of the economy. On the other hand, when rates drop, payouts might also decline.
Preference shares grant investors priority in dividend distribution and liquidation proceeds but generally lack voting power. On issuance, a company sets a fixed dividend rate. Dividends are paid at pre-agreed intervals—annually or quarterly—assuming sufficient profits. In liquidation, preference shareholders rank above equity but below creditors in the allocation of assets. Certain variants—such as convertible, callable, and adjustable—alter the dividend structure or ownership terms. This mix of predictable returns, prioritised claims, and optional features gives investors flexibility without full equity control.
Feature | Preference Shares | Equity Shares |
Dividend | Fixed or adjustable, paid before equity | Variable, subject to profits and board decisions |
Voting Rights | Generally, none, except in special cases | Full voting rights on policy, directors, etc. |
Asset Claim Priority | Higher than equity, lower than creditors | Last in the company's winding‑up |
Opportunity for Upside | Low through dividends | Highly possible from capital gains and bonus shares |
Risk Level | Moderate—lower volatility, stable income | Higher market fluctuations, no income guarantee |
Convertibility | Available in convertible types | Not applicable |
Let’s say “ABC Company” has 5000 preference shares in total to distribute to its stockholders. These shares have a price of Rs. 100 and earn interest at a rate of 7% annually. Due to certain circumstances, the company was not able to allocate dividends to its preferred shareholders in 2019 and 2020.
The preference shareholders are entitled to receive Rs. 1,05,000 by the end of 2021 before the corporation may pay its ordinary shareholders. This sum is the cumulative dividend that all stockholders have received after three years. This is an advantage of preference shares.
To summarise, investors must thoroughly grasp the various stock market shares and preference stock meanings. Individuals can choose their investment avenues depending on their objectives and risk tolerance.
Scenario | Tax Treatment |
Dividend income | Generally taxable at investor’s slab rate; no TDS threshold |
Capital gains (sale in exchange) | Short- or long-term gains taxed per IT Act rules |
Redemption (non-equity implications) | Treated as capital gain if listed; else, dividend-style tax may apply |
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Preference shares provide fixed dividends and priority in payments over equity shares, but they typically lack voting rights.
Key features of preference shares include fixed dividend payouts, priority during liquidation, and the absence of voting rights.
There are six main types of preference shares: cumulative, non-cumulative, convertible, non-convertible, redeemable, and non-redeemable.
Redeemable preference shares can be bought back by the company after a specified time, providing investors with a fixed return within a known timeframe.
Non-redeemable preference shares remain in circulation indefinitely, allowing companies to avoid repurchase obligations and potentially reinvest the funds for growth.
Convertible preference shares allow investors to convert their shares into equity, offering potential capital growth, but they may carry lower dividend rates compared to non-convertible shares.
Non-convertible preference shares provide stable, fixed dividends, ideal for investors seeking consistent income, while convertible shares offer potential for equity participation.
Participating preference shares allow shareholders to participate in surplus profits in addition to fixed dividends, enhancing their returns during profitable years.
They are treated as equity on the balance sheet, but their fixed income and priority payout traits resemble debt, qualifying them as hybrid instruments.
Any retail or institutional investor with a Demat and trading account can invest. Some issues may have minimum lot sizes or be reserved for qualified institutional buyers, depending on the offering terms.
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