It is not uncommon for a potential investor in your company to want treatment that is slightly better than the rest of the company’s shareholders. For instance, they may wish to receive preference shares in return for their investment. As the name suggests, these shares rank higher and often come with more substantial rights than ordinary shares.
This article will discuss the different types of preference shares and how a company can introduce them into its capital.
What is a Preference Share?
A preference share is one of the many types of shares that a company may offer to investors. Whilst the rights of the individual preference share may differ, their main characteristic is that they provide preferential treatment concerning insolvency. That is, in the event of the company winding up due to the inability to pay its debts, the holders of these shares will receive payment before the ordinary shareholders.
Other standard features include:
- receiving dividends ahead of ordinary shareholders or receiving higher dividends;
- receiving payment ahead of the ordinary shareholders in the case of an exit event; and
- Increase in voting rights at shareholder meetings.
What Are the Different Types?
There are several different types of preference shares. These are outlined in the table below.
| Convertible Preference Shares | The shareholder can convert their preference shares to ordinary shares at a certain time and by following a formula. If this occurs, the shareholder will lose their preferential rights. |
| Cumulative Preference Shares | A company cannot pay the dividends they owe to shareholders, the dividends will accrue, and the company pays them when they are financially stable. Only after the cumulative preference shareholders receive their dividends will the ordinary shareholders receive payment. |
| Redeemable Preference Shares | Shareholders with redeemable preference shares may redeem them for cash at the company’s discretion. |
How Do I Issue Preference Shares?
Section 254A of the Corporations Act 2001 (Cth) outlines a company’s power to issue preference shares. You can also find this information occasionally in the company’s constitution. A company’s constitution cannot override section 254A but can add additional steps. Therefore, checking that document to ensure you comply with the company’s governance requirements is important.
Issuing preference shares usually occurs when a new investor comes on board. Furthermore, you will likely negotiate the share’s terms with that party. At a minimum, the company and the investor must agree on the following about how these shares treat:
- repayment of capital;
- participation in surplus assets and profits;
- cumulative and non-cumulative dividends;
- voting;
- priority of payment of capital and dividends about other shares or classes of preference shares.
Introducing the Preference Share
Once these matters are confirmed, the company can introduce the preference share into its share capital in one of two ways. The company can either:
- amend its constitution to set out the share’s rights (which requires a special resolution of the shareholders); or
- pass a special resolution outlining the shareholder’s approval of the new class of preferential shares.
What Do I Need to Consider When Purchasing a Preference Share?
When purchasing a preference share, there are several things to consider, including:
- whether dividend rates are fixed or floating;
- whether the dividend is ‘franked’ (this means the company issuing the dividend partially pays the taxation to avoid double taxation of the share);
- how and when the share will convert into ordinary shares; and
- how it will interact with ordinary shares in the company and any other classes of preference shares that the company may issue.
Key Takeaways
A company may choose to issue several different types of shares. Therefore, it is essential to remember that some of these may be preference shares. If they are, they will contain one or many rights that rank them above the other shares in the company, such as preferential treatment in the case of the company’s insolvency. To introduce a new class of preferential shares, the company needs shareholder approval and must set out (at a minimum) the information contained in section 254A of the Corporations Act 2001 (Cth).
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Frequently Asked Questions
No. To be a preference share, it must rank above the other shares in the company in some way, for example, in the company’s insolvency.
There are many combinations of rights usually subject to heavy negotiation. However, the preference shares are cumulative, convertible or redeemable.
A can introduce a preference share by including the information in section 254A of the Corporations Act 2001 (Cth), in its constitution or by having those rights approved by a special resolution of the company’s shareholders.
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