In Short
-
Convertible preference shares give holders priority on dividends or liquidation, then convert to ordinary shares (usually on an exit event).
-
Whether you should convert depends on the size of the exit: if the business value is modest, keeping preference rights may pay more; if it’s high, converting may unlock greater upside.
-
Decide against conversion without assessing the trigger events (e.g., IPO or sale) and the company’s valuation — both determine if conversion makes commercial sense.
Tips for Businesses
Review your share-structure early: ensure you understand when conversion triggers apply and run scenarios for different exit valuations. That way you’ll be ready to advise investors and protect founder value when it’s time.
A company can issue different classes of shares, and the rights and restrictions attached to shares in a class distinguish it from other classes. Preference shares are considered the best form of equity security because of the liquidation and dividend preference rights usually attached to them. Hence, many people wonder what the purpose of a convertible preference share is. Convertible preference shares are preference shares that can be converted into ordinary shares. This article examines why anyone with a preference share would want to convert it to ordinary shares with lesser rights.
What Are the Different Types of Preference Shares?
Firstly, there are several different types of preference shares to consider. These include:
- convertible shares;
- converting shares;
- cumulative shares; and
- redeemable shares.
The below table goes into each type of preference share in further detail.
| Type | Description |
| Convertible Preference Share | Convertible preference shares start 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 Preference Share | Unlike convertible preference shares, these shares must convert to ordinary shares and usually do so at a fixed-dollar amount. |
| Cumulative Preference Share | Unlike convertible preference shares, these shares must convert to ordinary shares and typically do so at a fixed dollar amount. |
| Redeemable Preference Share | Shareholders with redeemable preference shares may redeem these for cash at the company’s or shareholders’ discretion, depending on their terms of issue. |
It is important to note that preference shares may have a liquidation preference in specified in the company’s constitution. A liquidation preference specifies when and how much the company will pay back investors in the event of an exit. However, the amount of liquidation preference can differ. As a holder of preference shares, the higher the liquidation preference multiple, the better. Currently, a 1x purchase price liquidation preference is standard in the Australian market.
When Do Convertible Preference Shares Convert?
Usually, convertible preference shares convert upon a liquidity event. A liquidity event is generally a share or business acquisition or an initial public offering (IPO). Preference shares usually convert into ordinary shares automatically on an IPO.
Continue reading this article below the formLiquidity Events
A shareholder with preference shares may have the option to convert preference shares into ordinary shares on a share or business acquisition. But in what circumstances would they do this?
Initial Public Offerings
Regarding an IPO, preference shares may automatically convert into ordinary shares if the constitution or shareholders’ agreement provides for this, provided specific pre-agreed criteria are met. Pre-agreed criteria may include:
- the amount raised by the IPO; and
- the price per share is set to ensure the IPO is legitimate and to prevent shares from converting on an IPO on a minor stock market from raising little money.
Share or Business Acquisitions
A shareholder with preference shares may be able to convert their shares into ordinary shares regarding share or business acquisitions. In what circumstances would they choose to convert their shares into ordinary shares with lesser rights?
To better answer the question, consider the following two scenarios with these facts.
A company has:
- an original investment by the shareholder with preference shares at $1 million;
- issued 10,000 preference shares issued to the shareholder (50%);
- 10,000 ordinary shares on issue (50%);
- a $2 million post-money valuation; and
- liquidity preference of 1x purchase price (this means the shareholder will get up to 1x its investment back on a liquidity event, assuming there are sufficient funds).
| Scenario 1 – acquisition price of $500,000 | If the shareholder does not convert their shares into ordinary shares, they would be entitled to $500,000 (via their liquidation preference). Alternatively, if they converted their preference shares into ordinary shares, they would receive $250,000 (50% of the acquisition price). In this scenario, it is better not to convert their preference shares into ordinary shares. |
| Scenario 2 – acquisition price of $4,000,000 | Suppose the preference shareholder does not convert their preference shares into ordinary shares. In that case, they will get $1 million (via their liquidation preference). If they convert their preference shares into ordinary shares, they will get $2 million (50% of the acquisition price). In this scenario, it is, of course, better to convert their preference shares into ordinary shares. |
Key Terms to Negotiate in Preference Share Agreements
When structuring preference share investments, several critical terms significantly impact the value and conversion decisions of these securities. The following are some key terms that may be considered:
- Liquidation Preference Multiples: While 1x liquidation preferences remain standard in Australia, some high-growth or later-stage investments may negotiate higher multiples (2x or 3x). Higher multiples provide greater downside protection but may reduce the likelihood that conversion becomes beneficial, as the liquidation preference threshold increases proportionally.
- Participating or Non-Participating Rights: Participating preference shares receive both their liquidation preference and their pro rata share of the remaining proceeds, significantly enhancing returns in successful exits. Non-participating shares must choose between the liquidation preference and the pro-rata share. Most Australian venture capital transactions employ non-participating structures to strike a balance between investor protection and founder incentives.
- Anti-Dilution Protection: Preference shares typically include anti-dilution provisions protecting against value dilution in subsequent funding rounds. “Weighted average” anti-dilution (broad-based or narrow-based) provides moderate protection, while “full ratchet” provisions offer maximum protection but are rarely accepted by companies due to their harsh impact on existing shareholders.
- Conversion Triggers and Mechanics: Beyond liquidity events, preference shares may convert upon achieving specific milestones such as revenue targets, profitability thresholds, or time-based triggers. Automatic conversion thresholds for IPOs typically require minimum proceeds and minimum valuation multiples to ensure legitimate public offerings.
- Board Rights and Control Provisions: Preference shareholders often negotiate board representation, protective provisions requiring their consent for major corporate decisions and information rights. These governance terms can significantly impact company operations and should be carefully balanced against operational flexibility requirements.
Understanding these terms enables informed decision-making about conversion timing and helps structure preference share investments that align with both investor protection and company growth objectives.
This handbook aims to help startup founders understand the benefits of venture debt, how a venture debt deal works and how to prepare for taking on this form of capital raising.
If your startup is in a high growth phase and looking to extend its cash runway, venture debt can be an ideal capital raising avenue.
Key Takeaways
Convertible preference shares are preference shares that can be converted into ordinary shares. Additionally, preference shares come with a liquidation preference. If the company becomes insolvent, the preference shareholders will be paid out before the ordinary shareholders. Ultimately, convertible preference shares typically convert upon a liquidity event.
If you need help with converting preference shares, our experienced capital raising lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Convertible preference shares start by paying fixed dividends at regular intervals. Then, they convert to ordinary shares or become redeemable for cash at a specified rate and time.
Unlike convertible preference shares, converting preference shares must convert to ordinary shares and usually do so at a fixed-dollar amount.
We appreciate your feedback – your submission has been successfully received.
