Generally a company may divide its shares into a variety of different categories unless it is restricted from doing so by its Articles of Association. Most people are familiar with ordinary common shares that are issued by companies which give their owners a claim on the equity of that company. A less familiar category of shares is preference shares. Preference shares are a special type of stock that has the properties of both equity and debt instruments such as bonds.
Preference shares have some of the traits of ordinary shares and some of bonds. The name preference refers to the rights attached to the shares which give them a preferential right over dividends and the return of capital.
Like a bondholder, a preference shareholder usually receives a fixed scheduled payment from the issuing company. Unlike a bond, this payment takes the form of a dividend which is paid out of the profits of the company and does not carry the same guarantees of payment. When dividends are paid, the preference dividend must be paid before any other dividends are paid out to other shareholders such as ordinary common shareholders or holders of deferred shares.
Usually the dividends on preference shares are presumed to be cumulative. This means that, where a company has insufficient profits to pay out a dividend in a single year, no dividend is paid out. However, the unpaid dividend remains payable so that, if the company has enough profit the following year to pay both the current and previous dividend it will be obliged to make up the previous dividend payment. There are cases where this presumption has been overturned so it is normal to find that the Articles of the company explicitly deal with this point.
Although structured as a share of the company, preference shares usually have much more limited voting rights than ordinary shares.
In addition to the right to receive a dividend, it is usual for preference shares to have a right to be treated preferentially on the winding up of a company. This effectively means that holders are prioritised above ordinary shareholders in respect of the return of paid-up capital. This right must be enshrined in the company's Articles to be effective and it must be carefully worded if arrears of outstanding preferential dividends are also to be included. It is also worth noting that preference shareholders remain subordinate to other creditors such as bondholders.