Preference shares and preferential issue are often mistaken for the same and used interchangeably. While both relate to raising capital, preference shares are a specific class of share capital with priority rights in dividend payment and capital repayment, whereas a preferential issue is simply a method of issuing shares or convertible securities to a select group of investors. The distinction is important for entrepreneurs, investors, and professionals, as each carries unique legal, financial, and strategic implications under the Companies Act, 2013 and, for listed companies, SEBI regulations.
In this blog, we will understand the meaning of both with a clear distinction between the two.
What is a Preference Share?
According to Section 43(b) of the Companies Act, 2013, preference share capital is that part of a company’s share capital which carries either or both of the following preferential rights:
- Right to receive a fixed dividend before any dividend is paid to equity shareholders.
- Right to repayment of capital on winding up before any payment is made to equity shareholders.
Thus, preference shares are hybrid instruments with characteristics of both equity and debt.
Features of Preference Shares
- Fixed dividend rate: Generally, preference shares have a pre-determined dividend rate, unlike equity shares, where the dividend depends on profits declared.
- Priority in dividend & capital repayment: Preference shareholders rank ahead of equity shareholders in both dividend distribution and return of capital.
- No voting rights (except in certain cases): Under Section 47(2) of the Companies Act, 2013, preference shareholders can vote only on matters directly affecting their rights or in case the dividend remains unpaid for a specified period.
- Redeemable nature: As per Section 55 of the Companies Act 2013, companies can issue only redeemable preference shares (i.e., shares repayable after a fixed period) with a maximum tenure of 20 years, except in certain infrastructure projects where it may be extended to 30 years.
Types of Preference Shares
1. Cumulative and Non-Cumulative Preference Shares
- Cumulative Preference Shares: If the company cannot pay dividends in a particular year due to insufficient profits, the unpaid dividend is carried forward and must be paid in the future before any dividend is given to equity shareholders.
- Non-Cumulative Preference Shares: If the company skips a dividend payment in any year, shareholders cannot claim it in the future. Dividends are paid only out of profits of the current year.
2. Redeemable and Irredeemable Preference Shares
- Redeemable Preference Shares: These are issued with the understanding that they will be repaid (redeemed) by the company after a fixed period or at a specific date. In India, only redeemable preference shares are allowed under the Companies Act, 2013.
- Irredeemable Preference Shares: These have no fixed repayment date and are meant to be held permanently. Such shares are not permitted in India.
3. Participating and Non-Participating Preference Shares
- Participating Preference Shares: Apart from their fixed dividend, these shareholders also have a right to share in surplus profits after dividends have been paid to equity shareholders.
- Non-Participating Preference Shares: These shareholders are entitled only to their fixed dividend and do not share in any additional surplus profits.
4. Convertible and Non-Convertible Preference Shares
- Convertible Preference Shares: These can be converted into equity shares of the company after a specified time or upon meeting certain conditions.
- Non-Convertible Preference Shares: These cannot be converted into equity shares and remain preference shares until they are redeemed.
What is a Preferential Issue?
A preferential issue refers to the allotment of shares or convertible securities to a select group of persons on a preferential basis, in compliance with Section 62(1)(c) of the Companies Act, 2013 and Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014. In the case of listed companies, preferential issues must also comply with Chapter V of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
Features of Preferential Issue
- Targeted allotment: A Preferential issue is issued to specific investors such as promoters, venture capitalists, private equity funds, or strategic investors.
- Board and shareholder approval: A Preferential issue requires a special resolution passed by shareholders and prior board approval.
- Pricing guidelines: For listed companies, the price of the preferential issue is determined as per SEBI regulations.
- Lock-in period: Securities allotted via preferential issue are subject to a minimum lock-in period to prevent immediate resale.
- Not limited to preference shares: Preferential issue can include equity shares, fully or partly convertible debentures, or any other securities convertible into equity.
Legal provisions governing preference shares and preferential issue
| Preference Shares | Preferential Issue | |
| Governing Law | Companies Act, 2013 (Sections 43, 47, 55) & related rules | Companies Act, 2013 (Section 62(1)(c) & Rule 13), SEBI ICDR Regulations (for listed companies) |
| Nature | A class of share capital | A method of issuing shares/securities |
| Objective | Provide fixed returns to confident investors while raising capital | Raise capital from specific investors without a public or rights issue |
| Type of Instrument | Equity with preferential rights | Equity shares, preference shares, debentures, or convertible securities |
| Voting Rights | Restricted | As per the type of security issued |
| Tenure | Maximum 20 years (except in specified cases) | Not tenure-bound; depends on the instrument issued |
Preference Shares Vs Preferential Issue
| Preference Shares | Preferential Issue | |
| Meaning | A class of shares with priority rights over equity shares in dividend and capital repayment | A private placement method to allot shares/securities to selected persons |
| Form | Specific category of share capital | Issuance process or method |
| Rights | Preferential rights as to dividend and capital | Rights depend on the nature of securities issued |
| Applicability | Applies to both private and public companies | Applies to issuance by private and public companies, and the listed companies must comply with the SEBI regulation. |
| Purpose | To provide investors with fixed returns and priority treatment | To quickly raise capital from targeted investors |
| Voting Rights | Limited | As per the security issued |
| Examples | Redeemable preference shares, cumulative preference shares | Issue of equity shares to a strategic investor on a preferential basis |
Conclusion
While both preference shares and preferential issues are tools for raising capital, their nature and scope differ significantly. Preference shares are a form of share capital with built-in preferential rights, whereas a preferential issue is a method of issuing shares or securities to select investors. In simple terms, the former is about what is being issued, and the latter is about how it is being issued.
Companies, investors, and advisors must understand these distinctions to choose the most suitable funding structure while ensuring compliance with the Companies Act, 2013 and SEBI Regulations where applicable.
