There are various types of Preferences Shares with differences in their structure. These are cumulative, non-cumulative, participating, non-participating, redeemable, irredeemable, convertible, non-convertible, callable, and adjustable-rate preference shares.
Preference shares are like senior citizens of a country who usually get preference almost everywhere. Like them, in an investment environment, the company issuing preference shares must pay a dividend to them before offering a single penny to equity shareholders. Similar is the situation in the event of bankruptcy; the residual money is used first to pay to the preference shareholders.
Various types of preference shares are seen in the market. The classification is on the basis of their different structure, maturity terms, the extent of participation, nature of dividend payment, etc.
Some of the common types of preference shares are as follows:
Convertible and Non-Convertible Preference Shares
Convertible preference shares have a similar concept to convertible debentures. These shares possess an option or right whereby they can be converted into an ordinary equity share at some agreed terms and conditions. Non-convertible does not have this option but has all other normal characteristics of a preference share.
Redeemable and Irredeemable Preference Shares
A redeemable preference share is a commonly seen preference share with a maturity date. The company will repay the capital amount to the preference shareholders on that date and discontinue the dividend payment thereon. Irredeemable preference shares are a little different from other types of preference shares. It does not have any maturity date, which makes this instrument very similar to equity, except that the dividend of these shares is fixed. They enjoy priority in paying both dividends and capital over the equity shares. Since there is an absence of maturity, they are also known as perpetual preference share capital.
Participating and Non-Participating Preference Shares
Participating preference shares are a unique type of preference share that has an additional benefit of participating in the company’s profits apart from the fixed dividend. The distribution may depend on the terms and conditions mentioned in the agreement, which may vary to some extent from case to case. Other preference shares that do not participate are called non-participating preference shares. Unless it has been mentioned that preference shares are participating, it is assumed to be non-participating.
Cumulative and Non-Cumulative Preference Shares
Nonpayment of preference dividend does not amount to bankruptcy, but this does not mean that the company’s liability is lost. If the shares are cumulative preference shares, the dividends are accumulated and therefore paid before anything is paid to equity shareholders. Even in liquidation, accumulated preference dividend and the preference share capital will be redeemed before any payment to equity shareholders. Whereas, for non-cumulative preference shares, if a company does not pay the dividend in the current year, the claim of the preference shareholder is lost to that extent. Unless it is specified that preference shares are non-cumulative, it is assumed that it is cumulative in nature.
Preference Shares with Callable Options
Whenever a company is issuing long-term fixed-rate dividend preference shares, at that time, the company has a risk of a decrease in the rate of preference dividend rate in the market. Hence, it may issue preference share with a callable feature. In that company has a right to redeem preference share in between. Such preference shares will be redeemed at a premium if redeemed in between because the investor will have a loss in that case. The company will exercise such an option if the rate of preference dividend is falling in the market.
Adjustable-Rate Preference Shares
These are some of the innovative types of instruments where the rate of dividend is not fixed. And is formulated based on some calculations relating to the current interest rates etc. These are adjustable rate preferred stocks.