There are a number of different types of shares that companies offer their investors. One of these being preference shares.  If you are looking to make an investment, but are unsure about the future of a company, becoming a preference shareholder may be the right decision for your finances. This article will explain how preference shares work so you can decide if they may be the best option for your future investments.

What are Preference Shares?

Where a company can no longer meet its financial obligations and falls into insolvency, preference shares receive preferential treatment. This means that they are paid out before ordinary shares. Preference shares vary and, depending on their structure, can be classified as ‘hybrid’ or ‘convertible’ securities. This means that they take on characteristics of both debt and equity.

Preference shares can be unlisted  (for private companies) or listed (for public companies) on the Australian Stock Exchange (ASX). They are similar to bonds in that they typically have a fixed maturity date. Meaning, there is a fixed date for when the you will recieve the money that you had invested.

Like ordinary shares, preference shares provide income payments in the form of dividends. The rate that preference share dividends are paid is either fixed or floating.

What Are the Different Types of Preference Shares?

There are a number of different types of preference shares to consider. These include:

Type Description
Convertible Convertible preference shares start off by paying fixed dividends at regular intervals. Then, they convert to ordinary shares or become redeemable for cash at a specified rate and time.
Converting Unlike convertible preference shares, these shares must convert to ordinary shares and usually do so at a fixed-dollar amount.
Cumulative If a company is not able to pay the dividends that they owe to shareholders, the dividends simply accrue and the company pays them when they are financially stable. Only after the cumulative preference shareholders receive their dividends will the ordinary shareholders also recieve payment.
Redeemable Shareholders with redeemable preference shares may redeem these for cash at the discretion of the company.

 

Will I Have Preference Over Other Shareholders?

As a preference shareholder, you rank ahead of ordinary shareholders if the company goes into liquidation. Liquidation occurs when the company is no longer able to meet its financial obligations and cannot pay off its debts. When this happens, your claim to the company’s assets is prioritised over other ordinary shareholders. Remember, however, that paying off the debts will still take priority.

In terms of the distribution of dividend payments, preference shareholders will also take priority over ordinary shareholders. These dividends are based on the profits of the company.

Can Preference Shares Be Converted?

Most types of preference shares are ‘convertible’ because they can, and usually will, turn into ordinary shares at some stage. The amount of ordinary shares you receive when your preference shares convert will depend on the method of conversion that you use. The company should outline the method of conversion in the legal documents that you receive during the initial issuing of the shares. You will usually receive the fixed dollar value of preference shares in ordinary shares at their present market value. This means that you will receive fewer shares if the market value of ordinary shares, at the time of conversion, is higher.

If your preference shares are listed on the ASX, you can sell them before they convert. To sell your unlisted preference shares, you will need to consult the company’s by-laws or articles of association.

What Should I Consider When Buying Preference Shares?

If you’re investing in preference shares, you should check:

  1. the dividend rate and whether it is floating or fixed;
  2. whether the dividend is franked. This means that the company (issuing the dividend) pays a portion of the tax on the dividend; and
  3. when and how the preference shares convert into ordinary shares.

Key Takeaways

Preference shares are potentially less profitable than ordinary shares. However, they offer more stability because the guaranteed dividends that the company pays at regular intervals are not tied to the financial pressures of the market. They are also an attractive investment because they are prioritised over ordinary shares when dividends are paid or during liquidation. If you have any questions about preference shares, contact LegalVisions’s business lawyers on 1300 544 755 or fill out the form on this page.

 

Lachlan McKnight
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