Preference Shares: Meaning, Types, Features, Pros & Cons

When you buy a share in a company, you are buying ownership in that company. There are two main types of shares that people can invest in: ordinary shares and preference shares. Preference shares are special because they give certain advantages to the shareholder over regular shareholders. These shares allow people to earn income from the company without taking too much risk. Let's dive deeper into understanding what preference shares are, their features, types, and what are the advantages and disadvantages of owning them.

What is Preference Share?

A preference share is a type of share that gives its holder a special advantage over ordinary shareholders. When a company earns profits, they usually pay a part of the profits to shareholders in the form of dividends. Preference shareholders get their dividends first, before ordinary shareholders.

These shares also give holders priority over ordinary shareholders when the company is liquidating, meaning if the company closes, preference shareholders will get their money back before ordinary shareholders. However, preference shareholders usually don’t have voting rights in the company, which means they cannot vote on major decisions like ordinary shareholders can.

Preference shares are like a mix of debt and equity. They are not as risky as regular shares, but they also don’t provide the same level of rewards. They can be a good option for investors looking for steady income with less risk.

Open Demat account -  Start investing with a quick setup

Features of Preference Shares

• Fixed Dividend: Preference shares offer a fixed dividend, which means shareholders get a set amount of money regularly, regardless of the company’s profit. This is one of the main benefits of owning preference shares.
• Priority Over Ordinary Shares: If a company goes bankrupt or faces financial issues, preference shareholders get paid first. They have higher priority when it comes to receiving payments compared to ordinary shareholders.
• No Voting Rights: Most preference shares do not give shareholders voting rights. This means that while they receive benefits from the company, they do not have a say in the company’s decisions, like electing directors.
• Cumulative vs. Non-Cumulative: Cumulative preference shares allow the company to delay dividend payments. If the company cannot pay a dividend in a certain year, they must pay it in the following years before paying dividends to ordinary shareholders. Non-cumulative preference shares do not have this feature, and the dividends are lost if not paid in a given year.
• Redeemable vs. Non-Redeemable: Redeemable preference shares can be bought back by the company at a later date, usually after a set period. Non-redeemable shares cannot be bought back and are permanent until the company is liquidated.

Types of Preference Shares

• Cumulative Preference Shares: This type of share ensures that if the company does not pay dividends in a certain year, they must pay it in the future years. So, shareholders do not lose out on any dividends.
• Non-Cumulative Preference Shares: In this type, if the company does not pay dividends in a particular year, the shareholder does not have the right to claim them later.
• Convertible Preference Shares: These shares can be converted into ordinary shares at a certain time in the future, which allows shareholders to enjoy the benefits of ordinary shares if the company does well.
• Non-Convertible Preference Shares: These shares cannot be converted into ordinary shares. The holders only receive dividends but do not gain the ability to convert them to common stock.
• Participating Preference Shares: These shareholders not only receive a fixed dividend but also get a share of the company's profit, after the ordinary shareholders have been paid.
• Non-Participating Preference Shares: These shareholders only receive the fixed dividend and do not participate in any extra profits of the company.

Advantages of Preference Shares

• Steady Income: One of the main reasons people buy preference shares is the steady and fixed income. Investors know they will get paid a set dividend regularly, which makes it a good option for income-seeking investors.
• Lower Risk: Compared to ordinary shares, preference shares are less risky because they give investors priority over dividends and repayment of capital in case the company faces financial issues.
• Priority Over Ordinary Shares: In case of bankruptcy or liquidation, preference shareholders are paid first, which reduces the risk of losing money.
• No Impact of Market Volatility: The price of preference shares doesn’t fluctuate as much as ordinary shares. This makes them a safer option during market downturns.
• Attractive to Conservative Investors: Investors who are risk-averse and prefer regular income often find preference shares attractive because of their fixed dividend and lower risk.

Disadvantages of Preference Shares

• No Voting Rights: Preference shareholders usually do not have voting rights. This means they cannot influence the company’s decisions, which might be important for some investors.
• Limited Capital Appreciation: Preference shares do not offer the same growth potential as ordinary shares. While ordinary shares can increase in value, preference shares only give a fixed dividend and no capital gain unless converted to ordinary shares.
• Fixed Dividend: While a fixed dividend is an advantage, it can also be a disadvantage in cases where the company does exceptionally well. Preference shareholders do not benefit from any extra profits, unlike ordinary shareholders who might get higher returns when the company succeeds.
• Not Ideal for Long-Term Growth: Preference shares are more suitable for short-term investments as they do not provide the same growth potential as ordinary shares. Investors looking for long-term capital growth might find preference shares less attractive.

Conclusion

Preference shares are a good investment option for people who want regular income with less risk. They are a hybrid between debt and equity, offering fixed returns with the safety of being paid first in case the company faces problems. However, they come with limitations such as no voting rights and limited capital appreciation. Understanding the different types of preference shares and their features will help you decide if they are the right choice for your investment goals. While they may not be suitable for everyone, they are a great option for conservative investors seeking stability and income.