What Are Preference Shares?
Most shares issued by companies are ordinary shares, but they are just one of the different types of shares available. Preference shares, sometimes also called ‘preferred shares’ or just ‘prefs’, can also be useful both to investors and the companies issuing them.
In this article, we look at the core features of preference shares, additional components that might be attached to them, and the advantages and disadvantages of preference shares to both investors and companies looking to raise capital.
Preference shares carry two preferred rights over other classes of shares:
A preferential right to dividends
Dividends on preference shares tend to be at a fixed level set in advance, unlike the variable (or often no) dividend payable on ordinary shares. Usually paid twice a year, preference share dividends must be paid out in full before any dividend can be paid on ordinary shares. However, it’s still possible preference shares will not receive a dividend in any year, as profits must exist from which to pay.
A preferential right to repayment of capital
If the company is wound up, preference shareholders are entitled to be repaid their capital contribution before ordinary shareholders receive anything. Like ordinary shares, however, preference shareholders will only be paid once other creditors have been paid in full.
Preference shares generally do not carry voting rights, which may limit their appeal. Usually, they can only vote in specific, extraordinary circumstances – for example, if a proposed change would affect the rights of the preference shareholders or if dividends due on preference shares remain paid.
Preference shares – a mix between ordinary shares and corporate debt
A preference share is sometimes described as a hybrid between an ordinary share and corporate debt, with some features of each.
Preference shares have the following features in common with ordinary shares:
- They are perpetual shares, with (usually) no requirement for the company to repay the amount invested during its lifetime. It is only on liquidation that a company has an obligation to return capital to shareholders.
- Like other types of shares, a company allots new shares that may then be transferred from one holder to another.
- Dividends can only be paid out of distributable profits.
- Dividends are not deductible as an expense when working out the company’s tax liability.
- Dividend payment is not obligatory. The directors of the company typically have discretion over whether a dividend should be paid or to reinvest profits into the business.
- They do not create any charge over the assets of the company.
- They sit below all secured and unsecured creditors, and only rank for repayment ahead of ordinary shareholders.
At the same time, preference shares have some features in common with corporate debt instruments:
- They carry a fixed rate of dividend, like the interest payment on corporate debt.
- They do not carry the right to vote.
- They rank ahead of ordinary shareholders for the return of capital in any liquidation event.
With this combination of features, in principle, a preference share will potentially achieve higher rewards but with higher risk than a debt instrument of the same company but lower rewards at lower risk than the company’s ordinary shares.
Features that may apply to preference shares
There are many additional features that can be added, individually or in combination, to preference shares. These may make them more attractive to potential shareholders or the company issuing them. The exact nature and any features of an issue of preference shares should be set out in the company’s articles of association.