Shares are the units of ownership in the share capital of a company and form the very basis of corporate finance. When a firm issues shares, it invites the public to provide capital in return for the right to own those shares and a share in the profits. The shareholders, in turn, acquire membership in the corporation and have varying rights, such as dividends, voting, and transfer of shares. In general, shares under the Companies Act 2013 may be categorised into different types based on the rights and privileges that come with them. The nature and types of shares are of utmost importance to investors and firms alike, as they play significant roles in capital formation and corporate development.
What are Preference Shares?
Preference shares are a class of shares issued by the company that are preferable to equity shares in two ways: in respect of dividends and in case of repayment of capital during liquidation. They have a degree in both equity and debt instruments.
Features of Preference Share:
- Preference shareholders receive dividends at a fixed rate.
- This type of dividend is paid out before the equity shareholders are paid their dividends.
- They have precedence in capital return in liquidation events.
- They are considered owners of the company, not creditors.
- Voting rights are limited and usually granted in very special circumstances only.
- Preference shares may be redeemed after a predetermined period and usually do not allow for participation in the management itself.
Types of Preference Shares
Preference shares are those types of shares that carry the right of precedence over equity shares in case of payment of dividends and return of capital upon winding-up of the firm. The issue of preference shares by Indian companies is governed by Section 43 of the Companies Act, 2013.
Preference shares are considered to be owners of the company, though with their rights more restricted than those of equity shareholders.
1. Cumulative Preference Shares
- These shares allow for the payment of dividends in arrears.
- If the company doesn’t declare a dividend in any one year, it gets accumulated.
- Dividends accrued so far need to be paid before distributing dividends to equity shareholders.
- By Default, the majority of preference shares that are trading in India are cumulative
For example, it would have accrued and then been paid later on if the dividend had not been paid for two consecutive years.
2. Noncumulative Preference Shares
- The dividends do not accumulate.
- If the dividend is declared in any particular year, the right to receive that year’s payment is lost.
- These are issued when profit-making is uncertain.
3. Participating Preference Shares
- Shareholders have the right to share in surplus profits in addition to receiving a fixed dividend.
- The excess of the assets is to be shared, after the company is wound up.
- Participating When the equity holders get their predetermined dividend, as well as a fixed dividend to the preference shareholders.
4. Non-Participating Preferred Shares
- The shareholders have a right to receive dividends at a predetermined fixed rate.
- They are not entitled to any further share in additional profit, bonus, or excess assets, in case of winding up.
5. Redeemable Preference Shares
- Shares are issued for a defined period.
- They are redeemed after a maximum duration of 20 years.
- The redemption may take place at par value or at a premium.
- Options for redemption may include either the profits or revenues generated from a new issuance of shares.
6. Irredeemable Preference Shares
- It is not possible for these shares to be redeemed during the life of the company.
- They are not allowed under the Companies Act, 2013.
- Only redeemable preference shares are allowed in India.
7. Convertible Preference Shares
- These shares are convertible into equity shares after a certain specified period of time.
- Terms of conversion are determined at the time of issue.
- This is the best option for investors looking for initial fixed income and potential equity participation later on.
8. Non-convertible Preference Shares
- Such shares cannot be converted into equity shares.
- The investors must hold on to these preference shares until they are redeemed.
- They generate consistent profits without diluting ownership interests.
9. Callable Preference Shares
- The company has the right to redeem these shares prior to maturity.
- The yield on the callable bond usually rises and then falls when market interest rates fall.
10. Non-Callable Preference Shares
- These shares are irredeemable before their maturity.
- They give investors a sense of stability.
11. Voting Preference Shares
- Preference shareholders do not generally have voting rights.
- In no event shall they, unless such dividend be in arrears for two years or more, have the right to vote on any motion.
Key Legal Considerations
- The Articles of Association provide limitations regarding the issuance of preference shares unless authorised.
- A statement indicating the dividend rate is required.
- Preference shares have no perpetual life.
- The redemption cannot be done through capital.
Rights of Preference Shareholders
The preferred shareholders also enjoy many other statutory and contractual rights to protect their investments. While they do not actively take part in the management of a company, their rights with respect to dividends, return of capital, voting in exceptional circumstances, and redemption provide financial stability. These rights create a balance between investor protection and flexibility for companies.
1. Right to Preference Dividend
- Preference shareholders have priority in the receipt of dividends.
- Dividend is paid at a pre-defined rate as determined at the time of issue.
- Dividends are paid before declaring the same to equity shareholders.
- Cumulative preference shares accumulate their dividends in case such a dividend is not paid, and the same shall be accounted for in future years.
2. Preference in Return of Capital
If a company is wound up, the preference shareholder enjoys precedence over the equity shareholder, though their claims rank after those of outside creditors and debenture holders.
3. The right to dividend arrears
- The cumulative preference stockholders have the right to demand the dividend arrears for the preceding year.
- The arrears should be paid before the declaration of dividends to equity stockholders.
4. Entitlement to participate in Surplus Profits
The preference shareholders are entitled to receive additional dividends after the declaration of the predetermined return to the equity shareholders. This is subject to the participation permitted by the Articles of Association.
5. Right to share in surplus assets
The participating preference shares have a right to take part in the surplus assets in case of liquidation, only after the satisfaction of capital.
6. Right to Vote on Certain Issues
Non-voting rights are common for preference stockholders. However, they can vote for the following motions:
- Those which may immediately and adversely affect their rights.
- During the course of the winding up of the business.
- In matters of repayment or reduction of stock capital.
- Those stockholders who do not receive dividends for two or more years acquire voting rights on all issues.
7. Right to Receive Notice of Meetings
It should also account for:
- Be sent notices of general meetings.
- They may be present during meetings relating to their rights.
8. Statutory right to inspect documents
They have the right to investigate: Formed under the incorporation documents:
- Memorandum of Association,
- Articles of Association,
- Register of Members, and
- Annual Financial Statements.
9. Right to Redemption
- Preference shareholders have the right to redeem their shares upon maturity.
- Redemption must be carried out in accordance with the issue terms and within the maximum legally permitted duration.
10. Transferring of Shares
Preference shares are transferable, subject to:
- Memorandum and Articles of Association
- Listing regulations (if applicable).
11. The right to seek a judicial solution
In cases of oppression, mismanagement, or infringement of rights, shareholders can resort to a tribunal or court.
Advantages / Benefits Of Preference Shares
Preference shares provide financial security for investors and funding flexibility for companies. The fixed rate of return, priority rights, and control make preference shares an important funding source for companies, as per the Companies Act 2013.
1. Priority in Dividend Payments
- Preference stocks have the right to receive dividends prior to the equity stocks.
- The dividend rate is determined to provide a fixed income.
2. Priority in Capital Repayment
In a winding-up, the preference shares are given precedence over equity shares.
3. Fixed & Regular Income
They give predictable returns to the risk-averse clients, such as retirees.
4. No Dilution of Control
- Preference shareholders have no voting rights.
- This ensures that companies are able to raise funds for capital expansion without losing management control.
5. Flexible Capital Structure
- Companies possess the capacity to create different kinds of preference shares based on their financial needs.
- This helps in striking a balance between debt and equity.
6. No mandatory charge on assets
Unlike debentures, preference shares do not issue any kind of charge on the assets of the company.
7. Ease of Redemption
- Redeemable preference shares allow companies to repay capital after a fixed period.
- Useful for long-term planning.
8. Cumulative Dividend
Dividends not paid on cumulative preference shares get accumulated and are paid after some time.
9. Suited to Investors Seeking Security
- Lower risk than common stock shares.
- Lower return volatility.
Conclusion
Preference shares act as an essential funding vehicle for businesses, as they retain the best features of both equity and debt. These instruments allow investors to enjoy a fixed dividend, preference in the payment of dividends, as well as preference in the return of capital in the event of company liquidation. Using different types of preference shares, such as cumulative preference shares, redeemable preference shares, or convertible preference shares, companies can effectively manage their capital structure to meet their financing requirements.
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