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Capital is the blood and bones of a business. Every business needs to raise capital to grow and operate smoothly. Companies that wish to raise additional capital need to follow a process prescribed by the Companies Act 2013. This process is the issue and allotment of new shares. Issue of new shares includes issuing a prospectus, receiving share applications, allotment of shares and calling of shares. New shares can be issued to either individuals or companies. Let’s understand what a share is and how preference shares are different from equity shares.
What is a Preference Share?
A share is a unit of ownership in a corporation. Equity shares and preference shares are the two main kinds.
As per Section 42 of the Companies Act, ‘the part of share capital to which the holders have a preferential right during payment of dividend and repayment of share capital in the event of company liquidation are preference shares.’ In simple terms, preference shares carry a preferential right while redeeming or in case the company is dissolved, and a fixed dividend is paid regularly.
On the other hand, equity shares are non-redeemable but offer full voting rights to their holders and expect returns in the form of price appreciation.
Differences between Equity Shares and Preference Shares
| Characteristics | Preference Shares | Equity Shares |
| Nature | Both equity and debt instrument | Pure equity instrument |
| Right to vote | Limited voting rights | Full voting rights: Equity shareholders are regarded as the owners and get to partake in the company’s decisions |
| Payment of dividend |
|
|
| Redemption | Can be redeemed in the future | Cannot be redeemed by the company |
| Convertibility | Can be converted into equity over time | Not convertible |
| Winding-up | Will be paid before equity shareholders in the leftover capital from creditors | After realising the costs of liquidation, payment to creditors and preference shareholders, the capital remaining will be shared in respective proportions |
Types of Preference Shares
Based on redemption, convertibility and voting rights, preference shares are classified into different types. Let’s understand them one by one.
Redemption
Based on when a company can redeem the share, a preference share is divided into two categories:
- Redeemable preference shares: The company can redeem these shares at a predetermined time or whenever they want in the future
- Irredeemable preference shares: In its lifetime, the company cannot redeem this kind of share except at the time of liquidation
Voting rights
A preference share does not come with voting rights by default. But sometimes, companies issue these shares with voting rights
- Participating preference shares: The holders of this share enjoy predefined, in most cases limited voting rights in addition to the benefits of other preference shares
- Non-participating preference shares: These are ordinary preference shares with no voting rights
Accumulation
A preference shareholder has the right to claim dividends at a pre-fixed rate in the company’s profits.
- Cumulative preference shares: Preference shares enjoy a pre-fixed dividend
- These cumulative shares offer the right to claim the dividend of previous years. Meaning if a company fails to pay the dividend on these shares, the unpaid sum will be cumulated over time and must be paid in future terms
- Non-cumulative preference shares: The company is obligated to pay dividends on these shares only when they gain profit
Convertibility
Based on whether a share can be converted into equity, preference shares are of two types:
- Convertible preference shares: These shares can be converted into equity shares over a specified period
- Non-convertible preference shares: Generally, most of the preference shares cannot be converted to a different class
Process of Issuing a Preference Share
The capital in private companies is distributed between its directors. Only the public companies listed in various stock exchanges issue the shares to the general public. The main steps in raising nominal capital through preference shares are discussed below.
Issuing a Prospectus
When a company decides to raise capital through preference shares, it issues a prospectus containing information such as:
- The price of a share
- Intended amount to be raised and the number of shares
- Pre-fixed dividend rate
- When the dividend will be paid—generally, annually
- The redemption period
- Whether the share is convertible
- Whether the share comes with voting rights
- Whether the shareholder can claim unpaid dividends of the previous term
- The allotment method
- Payment details of shares after allotment
- The last date to apply for shares
Receiving the Applications
After issuing the prospectus, the company accepts applications for the shares from prospective customers. Applicants must also mention how many units they want to buy.
Allotment of Shares
The company then allots shares as per its policies.
Issuing Shares
After allotting the shares, the company calls the amount to be paid for issued shares in one or multiple instalments. The method and days of payment will be called by the company according to prior notice or as indicated in the prospectus.
Conclusion
Preference shares involve fewer risk factors compared to equity. Returns are regular in the form of dividends, and the face value of the share is unchanging. In this article, we explained what preference shares are, the types of preference shares based on redemption, right to vote, accumulation and convertibility in nature, differences between equity shares and preference shares and the general issuance process of preference shares.
