Open In App

Preference Shares : Features, Types, Merits and Demerits

Last Updated : 07 Apr, 2024
Improve
Improve
Like Article
Like
Save
Share
Report

What are Preference Shares?

Preference shares are those shares that are issued with features like preferential claim to dividends and capital repayment with a fixed rate of return. Preference share capital is the capital acquired through the issuance of preferred shares. There are two ways in which preference shareholders are in a better position than equity shareholders :

  1. Receiving a fixed rate of dividend before any dividend is paid to equity shareholders out of the company’s net profits.
  2. Receiving their capital at the time of the company’s liquidation after the debts of its creditors have been settled.

In comparison to equity shareholders, preference shareholders have a preferential claim to dividends and capital repayment. Preference shares are similar to debentures in that they have a fixed rate of return. Furthermore, As the dividend is paid only at the discretion of the directors and only from profit after tax, these are similar to equity shares in that context. As a result, preference shares share some characteristics of both equity and debentures.

Types-of-Preference-Shares-copy

Features of Preference Shares

1. Fixed Rate of Dividend: Preference shareholders get dividends before equity shareholders at a fixed rate.

2. No Security: The preference shareholders do not get any security from the company against their shares. Besides, preference share capital is a part of the owner’s fund capital of the company.

3. Hybrid Security: As preference shares consist of the features of both equity shares and debentures, they are known as Hybrid Securties. Just like equity shares, the preference shareholders get dividends only when the company earns a profit, and just like debentures, preference shareholders get a fixed rate of return.

4. Voting Rights: Under general conditions, the preference shareholders do not have voting rights. However, if the dividends are not paid for two years or more, the preference shareholders get voting rights.

5. Help to Collect Large Amount of Funds: As cautious investors and financial institutions prefer to invest in preference shares of a company, it helps them collect a huge amount of funds. Besides, preference shares attract more public because of their fixed rate of return.

6. No Fixed Liability: Preference shareholders get dividend only when the company earns profit. Therefore, in case of losses, the company is not obliged to pay dividend to the preference shareholders.

Types of Preference Shares

Preference Shares are of the following types:

1. Cumulative Preference Shares: Cumulative Preference Shares are those that have the right to accumulate unpaid dividends in future years if they are not paid during the current year.

2. Non-Cumulative Preference Shares:  Non-cumulative Preference Shares are those on which dividends do not accumulate. It means that if a company does not declare dividends for any year, the right of dividend of such shareholders for that year will be lost.

3. Participating Preference Shares:  Participating preference shares are preference shares that have the right to participate in the additional surplus of a company’s shares after a dividend at a certain rate has been paid on equity shares.

4. Non-Participating Preference Shares:  Non-participating preferences are those who do not have the right to participate in the company’s profits.

5. Convertible Preference Shares: Convertible preference shares are preference shares that can be converted into equity shares within a certain time frame. 

6. Non-Convertible Preference Shares: Non-convertible shares are those that cannot be converted into equity shares.

Merits of Preference Shares

The merits of raising funds through preference shares are:

1. Consistent Income: Preference shares provide reasonably consistent income in the form of a fixed rate of return and investment safety.

2. Reasonable Safety of Returns: Preference shares are useful for investors seeking a fixed rate of return with low risk.

3. No Interference in Management: It has no effect on equity shareholders’ control over management because preference shareholders do not have voting rights.

4. Trading on Equity: Paying a fixed dividend rate to preference shares may enable a company to declare higher dividend rates to equity shareholders in good times.

5. Repayment of Principal Amount: In the event of a company’s liquidation, preference shareholders have a preferential repayment right over equity shareholders.

6. No Charge on Assets: Preference capital does not impose any kind of charge on a company’s assets.

Demerits of Preference Share

The demerits of raising funds through preference shares are:

1. Limites Appeal: Preference shares are not suitable for investors who are willing to take risks in exchange for higher returns.

2. Dilutes Claim of Equity Shareholders: Preference capital dilutes equity shareholders’ claims towards the company’s assets.

3.  Unreliable and Low Returns: As the dividend on these shares is only paid when the company makes a profit, there is no guaranteed return for investors. As a result, these shares may not be very appealing to investors.

4. No Tax Benefits: The dividend is not deductible as an expense from profits. As a result, there is no tax savings, as in the case of interest on loans.


Previous Article
Next Article

Similar Reads

Difference between Preference Shares and Equity Shares
Life-blood of any business is finance. Sufficient finance for the company helps to grow and expand the company. The financial needs of any business are concerned with the acquisition and utilisation of funds. It is done through planning, acquiring, utilising, managing, and controlling funds in connection with the business. Issuing shares is one of
5 min read
Equity Shares : Merits and Demerits
What are Equity Shares?A company's most important source of long-term capital is equity shares. Because equity shares represent a company's ownership, the capital raised through the issuance of such shares is known as ownership capital or owner's funds. A company must have equity share capital in order to be established. Equity shareholders are pai
5 min read
Advertising : Features, Merits and Demerits
What is Advertising?Any paid form of non-personal presentation and promotion of goods and services by an identified sponsor is known as Advertising. It is one of the most popular tools of promotion. Information or details regarding benefits, price, and availability of the products and services are provided with the help of advertising. The main aim
5 min read
Issue of Shares : Meaning and Types of Shares
What is Issue of Shares?Share capital is capital obtained through the issuance of shares. A company's capital is divided into small units called shares. Each share has a nominal value. For example, a company can issue 2,00,000 shares of Rs. 10 each for a total of Rs. 20,00,000. The person who holds the shares is referred to as the shareholder. A co
5 min read
Formal Communication: Meaning, Types, Merits and Demerits
What is Formal Communication ? Official communication taking place in an organisation is known as formal communication. It is related to the status or position of the sender and receiver. It generally takes place either between employees of different levels as in the case of superior-subordinate or at the same levels as in the case of two managers
3 min read
External Debt | Types, Effects, Merits and Demerits
External Debt can be defined as money borrowed from outside the country from sources like foreign governments, International Monetary Funds (IMF), Foreign Direct Investments (FDI), Foreign Portfolio Investments (FPI), etc. As people and businesses sometimes need to borrow money to pay their expenses, the same goes for the government of any country.
5 min read
ECS: Full Form, Objectives, Types, Merits and Demerits
What is ECS? ECS is defined as an electronic means for the transfer of funds introduced by the Reserve Bank of India to reduce the transit time of funds mobilisation so that repetitive and recurring payments can be processed easily and electronically without any manual intervention. This payment mode also ensures that paper transactions are minimis
9 min read
Arithmetic Mean: Meaning, Example, Types, Merits, and Demerits
A single value used to symbolise a whole set of data is called the Measure of Central Tendency. In comparison to other values, it is a typical value to which the majority of observations are closer. The arithmetic mean is one approach to measure central tendency in statistics. This measure of central tendency involves the condensation of a huge amo
8 min read
Forfeiture of Shares : Accounting Entries on Issue of Shares
What is Forfeiture of Shares?Cancellation of shares of a shareholder who fails to pay the amount due on allotment or on any call within the specific time period is known as Forfeiture of Shares. A company or its directors can forfeit the shares only if its Articles of Association allow for the same. If a company wants to make the forfeiture valid,
5 min read
Sources of Recruitment (Internal and External: Meaning, Merits and Demerits)
Recruitment can be defined as the process of publicizing information about various job vacancies in the organization. It is a process of searching for prospective employees and encouraging them to apply for the job in the organization. Recruitment is a positive process because it stimulates people to apply for the job. It is an important part of st
10 min read