Preference shares are those shares that rank for a fixed dividend out of the profits in priority to any other class of shareholders.
These shares may be preferential as to:
A) The payment of dividend
B) The repayment of capital, in priority to other classes of shares, in the event of winding up of the company.
Types / Classes of Preference Shares:
- On the basis of dividend rights.
- On the basis of convertibility.
- On the basis of refund of capital.
1. On the basis of dividend rights:
On the basis of dividend rights, preference shares are classified as under:
I) Cumulative Preference Shares:
Cumulative preference shares are those shares, the holder of which are entitled to recover the arrears of dividend, before any dividend paid on equity shares.
It means that, if any year, the profits of the company are insufficient to pay a dividend of these shares, the unpaid dividend KS treated as arrears and accumulating until the dividend is fully paid.
Such accumulated arrears dividend will be payable out of the profits of the subsequent years before the payment of dividend to the equity shareholder.
The arrears of dividends of these are shown in the balance sheet as a contingent liability.In India, a preference share is always cumulative unless specifically mentioned otherwise.
II) Non-cumulative Preference Shares:
Non-cumulative equity shares are those shares, the holder of which get a fixed rate of dividend each year out of the profits.
If any year, the company does not earn any adequate profits, the holder of such shares will not get dividends or get only a part of the dividend. The unpaid dividend will not be carried forward to the subsequent year’s arrears.
The holder of such shares has no claim for the arrears of dividend as the dividend arrears do not accumulate. The holder of which get a fixed rate of dividend as the dividend arrears do not accumulate.
2. On the basis of Convertibility:
On the basis of convertibility preference shares may be classified as under:
I) Convertible Preference shares: Convertible preference shares are those shares that have the rights to convert into equity shares.
II) Non-convertible preference shares: Non-convertible preference shares are those shares which do not have any right to convert into equity shares.
3. On the basis of refund of capital:
On the basis of refund of capital, preference shares are classified as under:
I) Redeemable Preference Shares: The preference share which can be redeemed /repaid after a special period leave at the discretion of the company are known as redeemable preference shares.
II) Irredeemable preference shares:
The preference shares which cannot be redeemable / repaid during the lifetime of the company are known as irredeemable preference shares.
4. On the basis of participation:
On the basis of the right to get a share in the surplus, preference shares are classified as under:
I) Participating preference shares: Participating preference shares are those shares the holder of which, in addition to basic preferential, have a right to participate in the surplus profit.
If any, remaining after payment of dividend to equity shareholder and to participate in the surplus assets remaining after payment to the equity shareholders at the time of winding up of the company.
II) Non-participating preference shares: The holders of such shares get only a fixed rate of dividend every year.
These shares do not carry any right to participate in the surplus profits or any surplus on winding up which remains after payment to the equity shareholders.
Difference between Equity shares And Preference Shares:
1. The rate of dividend on preference shares is fixed.
The rate of dividend on equity shares is not fixed.
2. If a dividend is not paid on preference shares in any year, the arrears of dividend may accumulative.
In the case of equity shares, the dividend does accumulate.
3. Preference shares have a right to receive the dividend before any dividend is paid on equity shares.
Payment of dividend on equity shares is made after the payment of preference shares.
4. Voting rights of preference shareholders are restricted.
Equity shareholders enjoy voting rights.
5. Preference shareholder has a right to return of capital in the case of winding up.
Equity shares capital is paid only when preference shares capital is paid out fully.
6. Preference shares do not have the right to participate in the management of the company.
Equity shares have the full right to participate in the management of a company.