What are preference shares?
Preference shares are a popular choice for investors seeking a stable income stream and enhanced capital protection as they offer fixed-rate dividends irrespective of the company's revenue earnings.
We've outlined what preference shares are and when they are useful.
Definition and Key Features
Preference shares, also known as preferred stock, are a type of share that holds a higher claim on the company's assets and earnings compared to ordinary shares.
These shares come with fixed dividends and hold priority over ordinary shares when it comes to dividend payments and liquidation.
However, preference shares usually come with limited or no voting rights. It is crucial to understand these features, as they significantly impact the investment and financing strategies of a business.
Comparison with Ordinary Shares
While ordinary shares are the most standard form of shares, preference shares come with a different set of characteristics. The primary contrasts between the two include differences in dividend rights, voting rights and risk profile.
Preference shareholders enjoy a fixed dividend and have a higher claim on the company's assets in case of liquidation, whereas ordinary shareholders receive variable dividends and have a residual claim on the company’s assets.
Types of Preference Shares
Redeemable Preference Shares
Redeemable preference shares come with an option for the company to buy them back at a future date, which is predetermined at the time of issuance.
This feature provides flexibility for the company and poses both risks and benefits for the investors. Companies may choose to redeem these shares if they believe it's financially advantageous for them, which may not always align with the interests of the shareholders.
Convertible Preference Shares
Convertible preference shares grant the holders the right to convert their preference shares into a specified number of ordinary shares at a predetermined price and date.
This option can be advantageous for the investor if the company’s ordinary shares appreciate in value. However, this conversion right also comes with the risk of the company's ordinary shares not performing as expected.
Cumulative vs. Non-Cumulative Preference Shares
Cumulative preference shares entail that if a company fails to pay dividends in any year, the unpaid dividends will accumulate and must be paid out before any dividends on ordinary shares.
On the other hand, non-cumulative preference shares do not accumulate unpaid dividends. This distinction is crucial for investors seeking a stable income stream from their investments.
Participating Preference Shares and dividend payments
Participating preference shares allow shareholders to participate in the company's profits beyond the fixed dividend. Shareholders receive an additional dividend based on the company's financial performance. This feature makes participating preference shares an attractive investment option for those looking to benefit from a company's success beyond the fixed dividend.
Why Companies Issue Preference Shares
Flexibility in Capital Management
Preference shares offer companies the flexibility to manage their capital better. They can issue preference shares to raise capital without diluting control since preference shares usually come with limited or no voting rights.
This can be particularly important for companies looking to raise capital while maintaining their current management structure.
Attracting Different Types of Investors
Preference shares can be an attractive option for investors looking for a more stable income stream as they offer fixed dividends and a higher claim on assets in case of liquidation. This can help companies attract a broader range of investors, including those looking for lower-risk investments.
Tax Considerations in the UK
In the UK, the tax implications for issuing or holding preference shares may differ from those of ordinary shares. The tax treatment of the dividends received on preference shares and the ability to claim tax credits may vary. It is advisable to consult a tax professional for specific tax considerations.
Investing in Preference Shares in the UK
The UK market presents several opportunities for investing in preference shares. Many well-established companies issue preference shares to raise capital, offering investors a chance to invest in stable entities with a lower risk profile.
Moreover, the London Stock Exchange lists several companies offering preference shares, providing a transparent and regulated environment for trading.
Risks and Considerations
While preference shares offer a more stable income stream and a higher claim on assets, they also come with certain risks.
These include interest rate sensitivity and the company's solvency risk. If interest rates rise, the value of preference shares may decline. Additionally, if the company faces financial difficulties, it may struggle to pay dividends or redeem the shares. Investors should carefully assess these risks before investing.
The UK has a robust regulatory framework that governs the issuance and trading of preference shares. The Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) are the main regulatory bodies overseeing the financial markets in the UK. It is crucial to understand the regulatory environment and comply with all the necessary requirements.
UK Companies that have Issued Preference Shares
Several notable UK companies have issued preference shares in the past. These include well-established entities like HSBC Holdings plc and Lloyds Banking Group plc. Investing in such companies may offer a lower risk profile compared to smaller or less established companies.
Preference shares play a crucial role in the UK market, offering companies flexibility in capital management and attracting a different type of investor. With various types of preference shares available, it is essential to understand their key features, benefits, and risks. As with any investment, it is advisable to consult a professional before making any decisions. Crest Legal is here to assist you with all your legal needs related to preference shares or any other commercial law matters.
What is the difference between ordinary shares and preference shares?
Ordinary shares, also known as common shares, are the most basic type of share available for investors.
They offer the holder the right to vote at shareholder meetings and the right to receive dividends, which are typically variable and dependent on the company's profits. However, they do not guarantee a dividend payout, and in the event of a company's liquidation, ordinary shareholders are the last to receive any leftover assets, after creditors, bondholders and preference shareholders.
Preference shares, on the other hand, are a type of share that typically does not provide voting rights. However, preference shareholders receive dividends before ordinary shareholders. In fact, these dividends are often fixed and paid out regularly, providing a predictable income stream. Furthermore, they hold a higher claim over the company's assets versus ordinary shares in case of liquidation.
The choice between ordinary shares and preference shares largely depends on the investor's risk tolerance and income needs. Investors seeking a regular income stream and greater security in a liquidation scenario may opt for these shares. Meanwhile, those willing to accept a higher level of risk for potentially greater returns and a say in company operations may lean towards ordinary shares.
Find out more about ordinary shares vs preference shares
Why would you buy preference shares?
Preference shares can be an attractive investment for several reasons. Firstly, they offer a fixed dividend, making them a stable and predictable source of income. This can be particularly appealing for risk-averse investors or those looking for a regular income stream to supplement their pension or other income sources.
Secondly, preference shares offer a superior claim on the company's assets in case of liquidation, ranking ahead of ordinary shares. This means that if a company goes into liquidation, preference shareholders are more likely to recoup some or all of their investment.
Finally, some preference shares are convertible, which means they can be converted into ordinary shares under certain conditions. This offers the potential for capital growth if the company performs well and the value of its ordinary shares increases.
However, like any investment, preference shares come with risks and are not suitable for everyone. Therefore, it is important to seek professional advice before investing.
What are the benefits of preference shares in a company?
Dividend Priority: Preference shareholders have the right to receive dividends before common shareholders. This means if a company declares dividends, they must first pay them to preference shareholders. If any funds remain after this, then they can distribute them among the common shareholders.
Liquidation Priority: In case of company liquidation, preference shareholders have a higher claim on assets and earnings. They get their investments back before common shareholders during the liquidation process.
Fixed Dividends: The dividends for preference shares are usually fixed, providing a steady income stream for investors.
No Voting Rights: Generally, preference shareholders do not have voting rights in the company. However, this might change if the company fails to pay the dividends.