Question

Answer the following question: What are Preference Shares? Explain the different types of Preference Shares.

Hint:

The name "Preference Share" says it all. They get 'preference' for two things: receiving a fixed dividend first and getting their capital back first if the company closes. The different types are just variations on these core rights.

Answer 1

Meaning of Preference Shares: As per the Companies Act, 2013, a preference share is one that carries two preferential rights over equity shares:

Preferential right to receive dividend: They are entitled to receive a dividend at a fixed rate before any dividend is paid to equity shareholders.
Preferential right to repayment of capital: In the event of the winding up of the company, they have the right to get their capital returned before the equity shareholders.
Preference shareholders are co-owners of the company but generally do not have voting rights, except on matters directly affecting their interests. They appeal to cautious investors who desire a fixed and steady income. Types of Preference Shares: Preference shares can be classified into the following types based on their features:

Cumulative and Non-Cumulative Preference Shares:

Cumulative: If a company fails to make a profit in any year, the dividend for that year is not lost but accumulates. These arrears of dividend are paid in subsequent years when the company makes a profit.
Non-Cumulative: The dividend for these shares does not accumulate. If the company does not make a profit in a particular year, the preference shareholders lose their dividend for that year forever.

Participating and Non-Participating Preference Shares:

Participating: These shareholders are entitled to a fixed dividend and also have the right to participate in the surplus profits of the company, after the dividend has been paid to equity shareholders up to a certain limit.
Non-Participating: These shareholders only receive their fixed rate of dividend and do not have any right to share in the surplus profits.

Convertible and Non-Convertible Preference Shares:

Convertible: The holders of these shares have the right to convert their preference shares into equity shares within a specified period, as per the terms of the issue.
Non-Convertible: These shares cannot be converted into equity shares.

Redeemable and Irredeemable Preference Shares:

Redeemable: These are shares that the company can buy back or 'redeem' after a fixed period. The Companies Act, 2013, allows companies to issue only redeemable preference shares, which must be redeemed within 20 years.
Irredeemable: These shares cannot be redeemed by the company during its lifetime. The Companies Act, 2013, has prohibited the issue of irredeemable preference shares in India.