July 29, 2020

Preference Shares – Advantages and Disadvantages

Preference Shares

The elements are of company securities are known as preferred stock. it’s the shares, that have an advantageous right to get a dividend and get back the initial investment at the time of winding up of the company. Preference shareholders are eligible to get a fixed rate of dividend and they do not have voting rights.

They may be classified into the following major types:

Cumulative:

Cumulative preference share has the right to claim dividends for those years which have no profits.If the corporate is unable to earn profit in anybody or additional years, C.P. Shares are unable to get any dividend but they have the right to get the comparative dividend for the previous years if the company earned the profit.

Non-cumulative:

The non-cumulative stock hasn’t any right to get pleasure from the higher than edges. They are eligible to get the only dividend if the company earns a profit during the years. Otherwise, they cannot claim any dividend.

Redeemable:

When the stock has a set maturity amount it becomes the redeemable stock. It is redeemable throughout the time period of the corporate. the corporate Act has provided bound restrictions on the come back of the redeemable stock.

Irredeemable

Irredeemable preference shares can be redeemed only when the company goes for the liquidator. There is no mounted maturity amount for such quite stock.

Participating

Participating preference shareholders have the right to participate in extra profits after distributing the equity shareholders.

Non-Participating

Non-participating preference shareholders are not having any right to participate in extra profits after distributing to the equity shareholders. Fixed-rate of dividend is payable to the type of shareholders.

Convertible

Convertible preference shareholders have the right to convert their holding into equity shares after a specific period. The articles of association should authorize the correct conversion.

Non-convertible

Their shares, cannot be converted into equity shares from preference shares.

Features

The following are the important features:

1. Maturity period:

Normally stock haven’t any mounted maturity amount except within the case of redeemable stock. These shares can be redeemable only at the time of the company liquidation.

2. Residual claims on income:

Preferential shareholders have a residual claim on income. Fixed-rate of dividend is payable to the preference shareholders.

3. Residual claims on assets:

The first preference is given to the preference shareholders at the time of liquidation. Fixed-rate of dividend is due to the preference shareholders.

4. Control of Management:

Preference shareholder does not have any voting rights. Hence, they can’t have management over the management of the corporate.

Advantages

These types of shares have the following important advantages.

1. Fixed dividend:

The dividend rate is mounted within the case of stock. It is called fixed-income security because it provides a constant rate of income to the investors.

2. Cumulative dividends:

Preference share has another advantage which is called cumulative dividends. If the company does not earn any profit in any previous years, it can be cumulative with the future period dividends.

3. Redemption:

Preference Share can be redeemable after a specific period except in the case of irredeemable preference shares. There is a fixed maturity period for the repayment of the initial investment.

4. Participation:

Participative preference shareholders will participate in the surplus profit when distribution to the equity shareholders.

5. Convertibility:

Convertibility preference share can be converted into equity share when the articles of association provide such conversion.

Disadvantages

1. Expensive sources of finance:

Have a high expensive source of finance while compared to equity shares.

2. No voting right:

Generally, preference shareholders don’t have any vote rights. thence they can’t have management over the management of the corporate.

3. Fixed dividend only:

These shares can get only a fixed rate of dividends. They may not enjoy more profits for the company.

4. Permanent burden:

Cumulative preference shares become a permanent burden so far as the payment of a dividend is concerned. Because the corporate should pay the dividend for the unprofitable periods additionally.

5. Taxation:

In the taxation purpose of reading, a stock dividend isn’t a deductible expense whereas calculative tax. But, interest is a deductible expense.  Hence, it has a disadvantage on the tax deduction point of view.

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