Most shareholders know that preference shares come with a liquidation preference. This means that if the company becomes insolvent, the preference shareholders will be paid out before the ordinary shareholders. However, preference shares will have other rights attached to them and can potentially be the subject of much negotiation. It is, therefore, worth knowing what the different options of preference shares are and what they mean. This article will explain the different types of preference shares so you can make the right choice for your investment.

Liquidation Preference

As discussed, all preference shares come with a liquidation preference. However, the amount of the liquidation preference can differ.

For example, your preference shares may come with a 1x purchase price liquidation preference. Therefore, if the company becomes insolvent, you will get 1x the issue price of your shares back before the ordinary shareholders get anything. Alternatively, if you have a 2x purchase price liquidation preference share, you will get 2x the issue price of your shares back before the ordinary shareholders get anything.

As a preference shareholder, the higher the liquidation preference, the better. Currently, a 1x purchase price liquidation preference is standard in the Australian market.

Participating Versus Non-Participating

If you have non-participation preference shares, you will not be entitled to the surplus assets and profits of the company once all the shareholders have been paid back. In comparison, if you have participating preference shares, you will be entitled to the surplus assets and profits of the company once all of the shareholders have been paid back.

As a shareholder, it is obviously more advantageous to have participating preference shares. However, non-participating preference shares are currently more standard in the Australian market.

Cumulative Versus Non-cumulative Dividends

Preference shares usually come with a preferential dividend. Therefore, the shareholders with preference shares are entitled to receive dividends before ordinary shareholders.

Rights to dividends can be cumulative or non-cumulative. If a company does not declare a dividend payable in a particular year, then preference shareholders with a right to non-cumulative dividends would lose the right to receive a dividend for that year. However, preference shareholders with a right to cumulative dividends would be able to carry over their right to receive a dividend for that year. They would also be entitled to receive that dividend in the future before any dividends are payable to ordinary shareholders.

As a shareholder, it is more advantageous to receive cumulative dividends, but non-cumulative dividends are currently more prevalent in the Australian market.

Convertible Versus Non-Convertible

Preference shares may be convertible or non-convertible. If they are non-convertible, the shareholder has no option to convert them into ordinary shares. If they are convertible, then the shareholder will have the choice to convert them to ordinary shares. This generally occurs at a pre-agreed time.

On conversion, all of the preferential rights of the preference shares (such as the liquidation preference) disappear, and the shares become ordinary shares. Convertible preference shares are better for the shareholder as they provide them with the flexibility to convert their shares if it is in their interests.

Redeemable Versus Non-Redeemable

Redeemable preference shares are shares that a company can redeem. Therefore, the company can buy the shares back on the term on which they are issued, using either:

  1. profits that would otherwise have been used to pay dividends; or
  2. the proceeds of new shares.

Generally, you can redeem redeemable preference shares either:

  • at a fixed time;
  • on the occurrence of a predetermined event;
  • at the company’s option; or
  • at the shareholder’s option.

On the other hand, the company cannot redeem non-redeemable preference shares. Non-redeemable preference shares are therefore generally better for the shareholder. However, it is possible that such shares may be subject to buy back provisions set out in the company’s shareholders agreement. It is likely that these provisions would have a similar consequence for the shareholder. This is especially true when they are a key person within the company.

Key Takeaways

There are various types of preference shares and the rights attached to them are greatly significant. Therefore, it is crucial to have a clear understanding of what these rights mean before issuing or accepting a particular type of preference share. If you have any questions on preference shares, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.
Jill McKnight

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