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Preference Shares

Tuesday, 10 July 2012

Preference Shares are a special type of stock that have features of both debt and equity securities. They are considered hybrid securities which generally rank above equities but are subordinate to debt instruments.

Company Constitution

The capital of a company can be made up of equity, debt and hybrid instruments depending on the authorisation in its constitution. The structures available to individual companies may vary because there is no general restriction preventing particular rights from being attached to different instruments.

Thus a company may, subject to its Articles, grant by ordinary resolution different levels of votes, different rights to dividends or different priorities in a winding up to certain classes of shares.

Common features of Preference Shares

  • Fixed dividends – preference dividends do not increase as company profits increase.
  • Fixed payments – payments are fixed but there may be provisions to not pay or for delay in certain circumstances.
  • Preferential rights to dividends - preferred dividends must be paid before normal dividends.
  • Cumulative dividends – if preferred dividends are not paid out when declared they are still owed such that the company must pay outstanding preferred dividends before paying normal dividends.
  • Preference in a winding up – preference shares may be given a priority right to return of capital in a winding up. This can be ahead of normal shareholders and in some cases other classes of preference shareholders.
  • Convertible – preference shares may be convertible into ordinary common stock.
  • Callable – preference shares may be callable by the issuing company which means it can redeem the shares in accordance with the call option, usually at par value.

Practical Implications of Preference Shares

Although they exist as stock, to the holders of preference shares they function in a similar manner to bonds. That is they pay a fixed rate, similar to an interest payment on a bond, at regular points in time. The dividend payments are normally specified as a fixed rate by reference to the par value of each bond and are cumulative unless structured otherwise.

Due to the fixed dividend, preference shareholders do not get to participate if the company increases its profits.

Other rights such as preference in a winding up of the company or conversion rights are not attached to preference shares per se but must be specified in the terms of the issue.

Call options benefit the issuer and are important considerations for the investor, particularly when preference shares trade above par due to the potential capital loss if the call is exercised.

Preference shares can be a useful source of finance for companies. Rollingsons has experienced lawyers who can offer advice regarding preference shares. If you would like more information, please contact James Crighton via e-mail or by telephone on 0207 611 4848.