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What are Preference Shares?

August 21, 2021   Philip Evangelou

If you are a business who is looking to raise capital, issuing preference shares is an option you should strongly consider. 

Preference shares are also known as preferred stocks and refer to shares in a company with dividends that are paid to shareholders before ordinary shareholders receive their dividends. 

Whether you own preference shares or ordinary shares can have significant implications in certain circumstances. In the event of bankruptcy for example, preferred stockholders are given preference and will be paid from the company’s assets before the ordinary stockholders. 

What Do Preference Shares Offer Potential Investors?

Offering preference shares provides businesses with an opportunity to attract more investors when they are looking to raise capital. This is due to the flexible nature and benefits that come with owning preference shares. 

Investing in a company always carries with it a degree of risk, so investors are always looking for ways to minimise the level of risk in their investment. 

Types Of Preference Shares

Preference shares can be further categorised into convertible or nonconvertible, cumulative or non-cumulative, participating or nonparticipating and redeemable or non redeemable. 

Convertible preferred stocks are those which include an option for shareholders to convert their preferred shares into a certain amount of common shares, usually after an already established date. Non-convertible shares on the other hand mean the shares can only be classified as preference shares and shareholders do not have the option of converting to ordinary shares. 

Cumulative preference shares are not as common in Australia. They are hugely beneficial to shareholders as they enable dividend entitlements to carry over to the following period, even when no dividends have been declared. Non-cumulative preference shares do not provide this benefit.  

Participating preference shares are also beneficial to shareholders as they are provided with the right to receive dividend payments at their specified rate, as well as dividend payments based on a predetermined condition being met. 

Alternatively, redeemable preference shares are those shares which are liable to be reclaimed by the company at a later date. Once the share is redeemed it is cancelled.  

What Does It Mean To Be A Preference Shareholder?

In the case that your company goes into liquidation, preference shareholders will receive priority over ordinary shareholders. 

This will affect their claim to the company’s assets, allowing preference shareholders to receive a price per share before ordinary shareholders. However, the payments made to both ordinary and preference shareholders occur after the payment of the company’s debts. 

Considerations When Issuing Preference Shares 

The benefits of priority and flexibility make preference shares quite attractive to investors. The financial protection investors derive from preference shares provides companies with a stronger ability to raise capital. 

Investors may insist on purchasing preference shares as a means of mitigating the inherent risk of investing in a startup. 

Key Takeaways

Issuing preference shares is a much safer option for investors who intend on purchasing shares in your company. This is due to the increased level of flexibility, reduced volatility and priority that is experienced with preference shares. 

There are also many different types of preference shares which may be suitable to your company or investors in different circumstances. 

About Philip Evangelou

phillipPhil is a director at OpenLegal. He has over 16 years experience working in private practice and in-house counsel in Sydney and London, giving him expertise in employment law, IP, finance, leases, dispute resolution, insurance and contracts.