10 Common Questions About Redeemable Preference Shares

Summary

• Redeemable preference shares are a type of share that a company can buy back in the future on agreed terms set out in its constitution or shareholder resolution. 
• They offer investors preferential rights (such as dividends or return of capital) while allowing the company to later return funds and cancel the shares. 
• Redemption must follow strict rules, including using profits or new share proceeds and ensuring the company remains solvent. 
• This guide explains redeemable preference shares for business owners in Australia, outlining how they work and key legal requirements, prepared by LegalVision, a commercial law firm that specialises in advising clients on corporate structuring.
• It provides a practical explanation of share terms, redemption conditions and compliance obligations such as ASIC notifications.

Tips for Businesses

Clearly set out redemption terms in your constitution or shareholder agreements. Ensure shares are fully paid and redemption does not affect solvency. Consider cash flow impact before issuing. Follow ASIC notification requirements and document decisions properly to avoid compliance risks.

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On this page

• 1. Who Has the Power to Issue Redeemable Preference Shares?
• 2. What are the Key Terms?
• 3. Does ASIC Need to Be Notified of an Issue of Redeemable Preference Shares?
• 4. When Can a Company Redeem These Shares?
• 5. Is Shareholder Approval Necessary?
• 6. How Much Will Shareholders Be Paid?
• 7. What Happens to These Shares When the Company Redeems Them?
• 8. Are There Other Ways the Company Can Buy Back Redeemable Preference Shares?
• 9. Does the Company Need to Notify ASIC?
• 10. Are Redeemable Preference Shares a Debt Interest or Equity Interest?
• Key Takeaways
• Frequently Asked Questions

Redeemable preference shares are a type of share that a company can issue and later buy back on agreed terms, giving investors priority rights while allowing the company to return capital at a future time. They are typically used as a flexible financing tool, with redemption conditions set out in the company’s constitution or shareholder agreements. This article explains how redeemable preference shares work and what you need to consider when issuing or redeeming them.

1. Who Has the Power to Issue Redeemable Preference Shares?

A company has the power to issue redeemable preference shares under the Corporations Act 2001. Specifically, the Corporations Act provides that a company has the power to issue shares, such as redeemable preference shares. However, the terms of these shares, including when a company can redeem them, must be:

• approved by a special resolution of shareholders; or
• set out in the company’s constitution.

2. What are the Key Terms?

The most fundamental term of any redeemable preference share is that the company must redeem them (i.e. repurchase them and pay back the issue price) at some point in time. When a company issues these shares, they must include the circumstances in which the shares must, or can be redeemed. Some common examples include redemption at:

• a fixed time or the happening of a particular event;
• the company’s option;
• the shareholder’s option;
• upon reaching a specific financial threshold; or
• after a minimum holding period has elapsed.

These varied redemption circumstances allow companies to tailor the terms of redeemable preference shares to their specific needs and financial strategies, while also accommodating different investor preferences.

A special resolution agreed to by shareholders or the company’s constitution will set out the key terms of the redeemable preference shares. These terms include:

• when the company will repay shareholders the initial price of their shares; and
• when shareholders have the right to be the company’s assets and profits.

Additionally, the terms of the redeemable shares will also detail whether shareholders:

• are entitled to cumulative or non-cumulative dividends;
• have the right to vote; and
• have the right to be paid in priority compared to shareholders holding shares of a different class.

Advanatages & Disadvantages

Redeemable preference shares offer both advantages and disadvantages for companies and investors. The advantages include:

• Flexibility in capital structure: Companies can raise capital without permanently diluting ownership, as the shares can be redeemed later.
• Attractive to investors seeking fixed returns: These shares often offer a fixed dividend rate, appealing to risk-averse investors.
• Temporary financing option: Ideal for companies needing short to medium-term funding without long-term commitment.

However, the disadvantages include:

• Higher dividend rates: Generally, preference shares require higher dividend rates than ordinary shares, increasing the cost of capital.
• Potential dilution of existing shareholders’ control: If convertible, these shares may dilute the voting power of existing shareholders upon conversion.
• Complexity in accounting and legal compliance: Issuing and managing these shares involves complex accounting treatments and legal requirements.
• Financial strain from redemption obligation: The company must have sufficient funds to redeem the shares when due, which can strain finances.

Redeemable preference shares provide flexibility in capital structure and appeal to risk-averse investors seeking fixed returns. For companies, they serve as an effective temporary financing option without diluting long-term ownership. 

However, these shares typically require higher dividend rates, increasing capital costs. They may also dilute existing shareholders’ control if convertible. Additionally, companies face complexities in accounting and legal compliance, as well as potential financial strain from future redemption obligations. 

3. Does ASIC Need to Be Notified of an Issue of Redeemable Preference Shares?

ASIC needs to be notified of an issue of redeemable preference shares. Importantly, a company needs to lodge with the Australian Securities and Investments Commission (ASIC) the following forms within 14 days of the share issue:

• form 2205 notification of resolutions regarding shares; and
• form 210 notification of statement or special rights carried by shares.

4. When Can a Company Redeem These Shares?

A company can only redeem these shares following terms as set out in its constitution. Parties must include some terms for any redeemable preference share, such as that the company cannot redeem the shares unless they are fully paid up. 

Further, the redemption payment must be made from the company’s profits, or the proceeds of a new issue of shares are made for the purpose of redemption. These restrictions exist to prevent redemption from reducing a company’s capital to the potential disadvantage of creditors.  

Even if a company redeems the shares without meeting the requirements, the company will not be guilty of an offence. Furthermore, the redemption transaction will still be valid. However, any person involved in the infringement, such as a director, may face penalties.

5. Is Shareholder Approval Necessary?

Shareholder approval is not necessary to approve the redemption of shares, so long as the company redeems the shares on their terms. Again, these terms will either be outlined in the company constitution or they will have recieved approval through a special resolution of the company’s shareholders.

6. How Much Will Shareholders Be Paid?

Once the company has redeemed the shares, it will pay the shareholder. The company will pay them in accordance with the share price in the terms for the shares.

7. What Happens to These Shares When the Company Redeems Them?

Upon redemption, the redeemable preference shares are cancelled. You should remember that a company’s redemption of the shares eliminates any dividend rights attached to them. An exception to this is where the terms of issue specify otherwise.

For example, the terms may specify that shareholders will receive a dividend payment out of any profits the company has made on completion of the redemption. 

8. Are There Other Ways the Company Can Buy Back Redeemable Preference Shares?

A company can redeem and cancel shares in a selective reduction of capital. However, such reduction must be approved by a special resolution of the redeemable preference shareholders and a company resolution in a general meeting.

A selective buy-back involves the company making non-identical offers to shareholders to buy their shares. Key points include the following:

• it requires shareholder approval via special resolution or unanimous agreement;
• the buy-back must not materially prejudice the company’s ability to pay creditors;
• directors must ensure it doesn’t cause company insolvency;
• companies must lodge Form 280/281 with ASIC within 14 days of entering into the buy-back and Form 484 within 28 days after the shares are cancelled (which typically occurs immediately after the buy-back is completed) otherwise, late fees will apply; and
• the members’ register must be updated accordingly.

Selective buy-backs are subject to strict regulatory requirements and timing constraints. While they offer some flexibility in terms of which shareholders’ shares are bought back, the process requires careful planning and implementation. Companies must consider various factors, including capital management, fairness to all shareholders and compliance with the Corporations Act’s stringent timelines and procedures.

9. Does the Company Need to Notify ASIC?

The company must lodge a Form 484 with ASIC to notify it of a completed redemption of redeemable preference shares within 28 days. Otherwise, late fees will apply. Form 484 sets out:

• the number of shares cancelled;
• any amount paid by the company (in cash or otherwise) upon the cancellation of the shares; and
• the class to which the cancelled shares belonged.

10. Are Redeemable Preference Shares a Debt Interest or Equity Interest?

Redeemable preference shares are hybrid securities, which generally combine debt and equity. Depending on their terms, the Australian Taxation Office (ATO) may classify them as a debt interest rather than an equity interest. This may have tax implications for shareholders. For instance, if classified as debt, the dividends paid may be treated as tax-deductible interest payments for the company. Shareholders may face different tax implications on their returns depending on whether they’re treated as interest or dividends.

Furthermore, directors should note that companies will incur debt in respect of these shares for the purposes of the insolvent trading provisions of the Corporations Act. This happens where a company exercises its option to redeem the shares or issues redeemable preference shares that are redeemable otherwise than at the option of the company.

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Key Takeaways

Companies can issue redeemable preference shares to shareholders and later redeem them on terms pre-agreed with the shareholders. These shares offer advantages such as flexibility in capital structure and attractiveness to investors seeking fixed returns. However, they also have disadvantages, including higher dividend rates and potential dilution of existing shareholders’ control.

The company may have the right to buy back shares at a fixed time, upon the occurrence of a particular event, or at the option of the company or the shareholder. Furthermore, the company will buy back the shares at the purchase price set out in terms of the issue of the shares. In doing so, the company must notify ASIC by lodging a Form 484, setting out the number of shares cancelled, the amount the company paid and the class to which the cancelled shares belong. Failure to do so may result in late fees.

Given these complexities, companies considering issuing redeemable preference shares should seek professional advice to navigate the tax and legal implications effectively. This ensures compliance with relevant regulations and optimal structuring for both the company and its shareholders.

LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced corporate lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.

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