Types of Preference Shares
Updated: Aug 22, 2021
A company’s share capital may be divided into different classes. It may issue different types of shares with different conditions. The most common two main classes of shares are ordinary shares and preference shares.
Ordinary shares: Carry voting rights and entitle shareholders to variable rates of dividends (i.e. payments to shareholders from profits of the company)
Preference shares: Has preferential rights over ordinary shares, usually in respect of dividend distributions, typically a fixed dividend.
A preference share entitles the holder to preferential rights either to dividends, return of capital or a combination of both. For example, many preference shares carry a right to receive a higher percentage of dividends than ordinary shares.
These are company shares with dividends that are paid to shareholders before ordinary share dividends are paid out. Preference share shareholders have the right to receive capital before ordinary share shareholders, in the event of company bankruptcy.
The rights attached to a particular class may be set out either in the company’s constitution or in a resolution authorising the issue of the class of shares in question passed during meetings. The specific rights and benefits of preferential shares are commercial decisions decided by each company.
Preference share shareholders usually do not have voting rights unlike ordinary share shareholders.
Rights of Holders of Preference Shares Set Out in Constitution
A company may not allot any preference shares or convert any issued equity shares into preference shares unless the rights of the holders of those preference shares are set out in its constitution with respect to repayment of capital, participation in surplus assets and profits, cumulative or non-cumulative dividends, voting and priority of payment of capital and dividend in relation to other shares or other classes of preference shares.
Redeemable Preference Shares
A company having a share capital may, if so authorised by its constitution, issue preference shares which are, or at the option of the company are to be, liable to be redeemed and the redemption shall be effected only on such terms and in such manner as is provided by the constitution.
A redeemable preference share is one where the company will pay the shareholder a specified sum by way of redemption of the share. Redeemable shares may be made redeemable at the option of the shareholder or the company.
Cumulative Preference Shares
These are preference shares which carry a right to cumulative dividends. This means that if the holders of preference shares are not paid in full the agreed percentage of dividends for a particular year, this is carried forward to the following year as a debt owing by the company to such holders.
Participating Preference Shares
These are shares which not only carry a preferred right to dividends but also entitle the holder to participate in the balance of profit remaining after the other shareholders received their dividends.
Convertible Preference Shares
The right to convert the preference shares to shares of another class after a certain date attaches to the preference shares.
A company the share capital of which is divided into different classes of shares may make provision in its constitution to authorise the conversion of one class of shares into another class of shares.
A private company may convert shares from one class to another by lodging a notice of conversion in the prescribed form with the Registrar.
A share that is not a redeemable preference share when issued cannot afterwards be converted into a redeemable preference share.
Preferential Right to Capital on Winding Up
Preference shareholders could be given the preferential right to receive repayment of the capital they contributed to the company on its winding up. Additionally, they can be given the right to share in any surplus assets of the company upon its winding up after receiving their capital contributions, but this is the exception rather than the rule.
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