This article is written by Calista Chettiar, a Second-Year BA. LL.B. (Hons.) student from NMIMS, School of Law, Bangalore.
INTRODUCTION:
Preference shares, commonly known as preferred stocks, entitle their holders to dividend payments from corporations at an earlier date than common stockholders. In the event that a corporation decides to distribute dividends to its shareholders, preference shareholders will be the first to receive their share of the dividend.
According to the Companies Act, 2013, companies in India can issue two distinct types of stock: equity shares and preference shares. In addition, if a company is liquidated, the preference shareholders will be paid in full before the ordinary shareholders. Redeemable preference shares are preferred shares that can be cashed in before their 20th anniversary. According to the Companies Act of 2013, Indian corporations cannot issue preference shares that cannot be redeemed.
WHAT IS PREFERENCE SHARE CAPITAL?
Preference share capital refers to the money a corporation gets from investors in exchange for issuing preference shares. The shareholders of Preference Shares, as the name implies, receive dividends from the corporation at a fixed dividend rate prior to the shareholders of Equity Shares. Preference share capital refers to the funds raised via the issuance of preference shares. Preference shareholders do not have voting rights and so cannot direct the company’s management. Preference shareholders receive payment from the company’s assets before common shareholders in the event of insolvency.
These shares are entitled to a predetermined dividend and have priority when it comes to receiving distributions and claiming assets in the event of a liquidation. In terms of capital payback and priority, these shares fall in between debt and equity. Preference shareholders are a subset of the company’s owners, in the same way, that equity shareholders are. However, they lack the ability to directly affect company choices because they do not have voting rights.
Bonus shares being non-claimable by shareholders also stands out as a key distinction between preference shares and equity shares. Preference stock dividends are discretionary and need not be paid in the event of a loss.
TYPES OF PREFERENCE SHARES:
- Cumulative Preference Shares – It’s a prevalent form of preferred stock that guarantees dividends even in years where the company doesn’t make enough money to distribute dividends. If a firm doesn’t make enough money one year, for whatever reason, it could not be able to distribute dividends. If profits are high enough, dividends will be paid the next year in arrears. Shareholders who possess cumulative preferences are entitled to dividend payments in years when the company is not profitable.
- Non-Cumulative Preference Shares – In years where the company has losses or inadequate profits, non-cumulative preference stockholders will not receive dividend payments. For instance, if a firm says it will pay dividends but then doesn’t, it doesn’t have to really pay those dividends. The dividend preference of non-cumulative preference shares is not carried forward from one year to the next.
- Redeemable Preference Shares – Redeemable preference shares are issued by companies with the intention of eventually redeeming them. Also, firms have 20 days from the date of issue to redeem these preference shares. A different name for these stocks is “callable preference shares.”
- Irredeemable Preference Shares – Preference shares that are not redeemable until the business is dissolved are considered irredeemable. Yet, Indian businesses are prohibited from issuing preference shares that cannot be redeemed.
- Convertible Preference Shares – The terms and conditions of the issue determine the price and period at which Convertible Preference shares can be converted into common equity shares of the corporation. It has the greatest flexibility of any preferred equity structure. Dividends and the potential for greater gains if the share price improves are the two primary ways in which shareholders are compensated.
- Non-Convertible Preference Shares – Non-Convertible Preference Shares cannot be changed into the company’s regular equity shares. Yet, in the event of the company’s dissolution, they continue to hold preferred rights to the payment of capital over common shareholders.
- Participating Preference Shares – Participating Preference Shareholders have a possibility to profit above the stated rate of fixed dividends. If the business generates excess profits over the established earnings benchmark, the dividends paid to these shareholders are higher. The possibility to participate in the company’s surplus or profits is available to shareholders in addition to receiving fixed dividends. Participating preference shares of businesses with promising prospects for high revenue and profit are available for investment.
- Non-Participating Preference Shareholders – Non-Participating Preference Stockholders have a right to pre-determined dividend payments. They are not eligible to share in the company’s excess profits.
- Adjustable Preference Shares – A set dividend rate under adjustable preference shares is not available to shareholders of adjustable preference shares. The dividend payments are based on the market interest rates.
WHAT IS THE DIFFERENCE BETWEEN EQUITY AND PREFERENCE SHARES?
Equity Stockholders have voting privileges within the company. Preference shareholders do not have voting rights, although they own the same amount of the corporation as equity shareholders.
When it comes to the payment of capital in the event of a company’s dissolution and the distribution of fixed-rate dividends, preference shareholders are given preference over equity shareholders.
Preference share dividends are cumulative, which is another important distinction between preference shares and equity shares. Even if it isn’t paid out for a while, the equity share dividend is not cumulative. Preference shares can also be redeemed, but equity shares cannot.
Equity shareholders can participate in the management of the company because they have voting rights. Preference shareholders do not have voting rights, however, so they are unable to participate in the management of the company. Also, while preference shares are not required for all corporations to issue, doing so is a requirement for equity shares.
VOTING RIGHTS [SEC 47 (2)]:
Preference The only matters on which shareholders are entitled to cast a vote are those which:
- Have an immediate impact on the preferences that come with their shares of stock
- Any proposal to dissolve the company
- A vote to reduce or eliminate the company’s equity or preference share capital.
Each shareholder’s vote counts the same as his or her fraction of the company’s paid-up preference share capital.
ISSUANCE OF PREFERENCE SHARES:
The Act forbids preference shares that cannot be redeemed. Under the terms and conditions set forth below, a limited by-shares company may issue preference shares with a redemption period of no more than twenty years from the date of issue. Preference shares may be issued for a term of more than 20 years but less than 30 years by a company involved in the establishment and dealing with “infrastructural projects” (as defined in Schedule VI of the Companies Act, 2013), subject to the redemption of at least 10% of such preference shares per year beginning in the 21st year or earlier on a proportionate basis at the option of the preference shareholders.
Preferred stock is a good option for long-term investors who seek a steady stream of dividend payments. Preference shares appeal to a wide spectrum of investors due to the alternatives they provide. Before putting your money into such stock, you should weigh the benefits and drawbacks and make sure they fit in with your overall investing strategy and comfort level with risk.
REFERENCES:
https://taxguru.in/company-law/note-preference-shares-companies-act-2013.html
https://www.indiafilings.com/learn/preference-shares-in-private-limited-company/