What Are Preference Shares? Types, Benefits and Key Differences 

Preference shares, also known as preferred stock, represent ownership in a company with a key distinction: its dividends are paid before common stock dividends. In the event of bankruptcy, preferred stockholders also have a higher claim on the company’s assets than common stockholders. While most preferred shares offer a fixed dividend, common stock dividends are typically variable. Another key difference is voting rights: preferred stockholders typically do not have voting rights, while common stockholders typically do. 

Understanding Preference Shares, what are the main types of preference shares?  

Preference shares are classified into four types:  

• Cumulative 

• Non-cumulative 

• Participating 

• Convertible 

• Cumulative preferred stock requires the company to pay all dividends due, including any arrears, before common stockholders receive distributions. These dividends are guaranteed, though not always paid on time, with unpaid amounts, called “dividends in arrears,” legally due to the current stockholder at the time of payment. Sometimes, additional compensation (interest) is also given.  

               Quarterly dividends are calculated as: 

               [(dividend rate) × (par value)] ÷ 4 

               And cumulative dividends per share are: 

              The quarterly dividend × The number of missed payments. 

• Non-cumulative preferred stock does not accrue unpaid dividends; missed dividends are simply forfeited. 

• Participating preferred stock entitles its holders to the stated preferred dividend rate plus additional dividends if common stockholder earnings exceed a certain level. In the event of liquidation, participating preferred shareholders may also receive back the purchase price and a proportionate share of the remaining proceeds. 

• Convertible preferred stock allows its holders to convert their shares into a fixed number of common shares, usually after a specified date. Conversion is usually at the discretion of the shareholder, but sometimes the company or shareholders can force it. The value of convertible preferred stock depends on the performance of the underlying common stock. 

What are the main types of preference shares? 

Preference shares are broadly categorized into cumulative, non-cumulative, participating, and convertible types. Cumulative preferred stock obligates the issuer to pay all past and present dividends before any common stock dividends are distributed, a feature absent in non-cumulative preferred shares. Consequently, cumulative preferreds typically command a premium over non-cumulative.  Participating preferred shares offer the potential for additional dividends if predetermined performance benchmarks, like exceeding profit targets, are met. Finally, convertible preferred stock, akin to convertible bonds, grants the holder the option to convert their preferred shares into common shares at a set price. 

Difference between preference shares and ordinary shares  

Preferred shares and ordinary shares provide investors with equity ownership in a company, and are preferred by institutions as tools for raising capital rather than debt. However, there are significant differences between these types of share, as outlined in the table below: 

Feature	Preference Shares	Ordinary Shares
Definition	Financial instrument used by companies to raise capital, offering dividend options.	Financial instrument used by companies to raise capital, offering voting rights.
Dividend Rate	Fixed dividend rate.	No Fixed dividend rate.
Voting Rights	No voting rights on key company decisions.	Voting rights on key company decisions.
Bonus Shares	Not eligible for bonus shares.	Eligible for bonus shares.
Role in management	No management role.	Management role.
Dividend Arrears	Claim on dividend arrears.	No claim on dividend arrears.
Share Types	The different types of preference shares: – Cumulative Preference Share. -Participating Preference Share. – Redeemable Preference Share. – Convertible Preference Share. – Non-Cumulative Preference Share. – Non-Participating Preference Share. – Non-Redeemable Preference Share. – Non-Convertible Preference Share.	The different types of ordinary shares: – Authorised Share Capital. – Issued Share Capital. – Subscribed Share Capital. -Paid-up Share Capital. – Right Share. – Bonus Share. – Sweat Equity Share.

Advantages of Preferred Stock 

Preferred shareholders benefit from fixed dividend payments, which take priority over distributions to common shareholders. While dividends are conditional on the company’s profits, cumulative preferred share offers a key advantage: any accumulated unpaid dividends (arrears) must be paid to preferred shareholders before any common stock dividends are issued. This ensures that preferred shareholders are compensated for missed payments once the company returns to profitability. 

Higher Claim to Company Assets 

In a bankruptcy and liquidation scenario, preferred shareholders have a senior claim to assets compared to common shareholders. This downside protection makes preferred shares attractive to more conservative investors. 

Additional Investor Benefits 

Preference shares can offer additional benefits to investors. Convertible preference shares allow conversion into a fixed number of common shares, providing a potential profit if the value of the common stock appreciates. Participating preference shares provide the opportunity to receive additional dividends above the fixed rate if the company achieves pre-defined profit targets. 

Disadvantages of Preference Shares 

A key disadvantage of preference shares is the lack of voting rights afforded to common shareholders.  While the guaranteed return on investmen can compensate for this shortcoming, rising interest rates can diminish the appeal of the fixed dividend that once seemed so lucrative can dwindle, potentially leading to buyer’s remorse as preference shareholder investors may find better returns in higher-interest fixed-income products. 

Company Benefits 

Preference shares offer several advantages to issuing companies. The absence of voting rights for preferred shareholders enhances the control of the company. In addition, callable preferred shares allow companies to repurchase shares at their discretion. This provision allows companies to reduce their cost of capital; for example, if callable shares are issued at a 6% dividend and interest rates later fall to 4%, the company can repurchase the outstanding shares and reissue them at the lower rate. However, this flexibility presents a disadvantage to preferred shareholders. 

In conclusion, preference shares offer a unique combination of equity ownership and fixed income characteristics, appealing to investors seeking stable income and downside protection.  

However, the lack of voting rights and the potential for missed dividends are important considerations. For companies, preference shares provide a flexible financing tool with limited impact on shareholder control.  

Understanding the nuances of preferred shares is critical for both investors and issuers navigating the complexities of capital markets. 

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