Understanding Preference Share Capital
Preference share capital represents funds raised by a company through the issuance of preference shares. Preference shares, sometimes known as preferred stock, offer certain advantages, particularly in terms of dividends and claims on assets during liquidation. They are known for providing a fixed rate of return, making them an appealing option for income-focused investors. Unlike common shares, preference shares typically do not confer voting rights.
Classification of Preference Share Capital
Historically in the UK, preference share capital was regarded as non-equity share capital. However, regulatory and accounting changes now dictate that preference shares are classified as liabilities rather than part of shareholders’ equity. This reclassification affects how companies report their financial conditions and balance their funding strategies between equity and debt.
Key Characteristics
- Dividend Priority: Preference shareholders receive dividends before common shareholders.
- Fixed Returns: Generally, the dividends on preference shares are fixed.
- Non-Participatory: Preference shares usually lack participation in the company’s profits beyond the fixed dividend.
- No Voting Rights: Typically, preference shareholders do not have voting rights in the company’s general meetings.
Examples of Preference Share Capital in Practice
- Convertible Preference Shares: These shares can be converted into a predetermined number of common shares, offering the potential for capital appreciation.
- Cumulative Preference Shares: If the company misses dividend payments, they accumulate and must be paid out before common dividends.
- Redeemable Preference Shares: These shares may be bought back by the company at a future date.
Frequently Asked Questions (FAQs)
Q1: What are preference shares?
A1: Preference shares are a type of share that gives shareholders preferential treatment in dividend distribution and during asset liquidation, generally offering fixed payments and no voting rights.
Q2: How are preference shares different from common shares?
A2: Preference shares offer fixed dividends and priority in asset distribution but usually do not provide voting rights, unlike common shares that may offer dividends based on the company’s profitability and include voting rights.
Q3: Are preference shares considered debt or equity?
A3: In many jurisdictions, including the UK, preference shares are classified as liabilities, aligning more closely with debt instruments than equity.
Q4: Can preference shareholders participate in company growth?
A4: Generally, preference shareholders do not participate in additional company profits beyond their fixed dividends, unless the shares are convertible.
Q5: What is the impact of not paying dividends on cumulative preference shares?
A5: For cumulative preference shares, unpaid dividends accumulate and must be paid in the future before any dividends can be distributed to common shareholders.
Related Terms
- Equity Capital: Funds raised from shareholders in exchange for ownership rights.
- Debt Capital: Borrowed money that the company must repay with interest.
- Convertible Bonds: Debt instruments that can be converted into a specified number of common shares.
- Preferred Stock: Another term for preference shares, commonly used in the USA.
Further Reading
Online Resources
Suggested Books
- “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset” by Aswath Damodaran
- “The Essays of Warren Buffett: Lessons for Corporate America” by Warren Buffett and Lawrence A. Cunningham
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, Franklin Allen
Preference Share Capital Fundamentals Quiz
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