Preference shares, also known as preferred stock, are a type of security issued by a company to raise capital. They represent ownership in the company but come with distinct features that differentiate them from ordinary shares. These shares combine equity and debt features, offering investors a fixed dividend, priority in dividend payments over common shareholders, and the option to convert them into common shares.
The key attraction of preference stocks lies in their promise of stable income, making them a favored choice for income-oriented investors. They also play a crucial role in a company’s capital structure, providing a source of funds that doesn’t dilute the voting power of common shareholders.
Preference shares represent an asset class that combines features of both common stocks and bonds, offering a blend of benefits for companies and investors alike.
- Enhanced Funding Opportunities: Preference shares can attract investors who seek more stable dividends and better protection in the event of bankruptcy compared to common stocks, thereby enabling companies to secure additional funding.
- Improved Financial Metrics: By issuing preference shares rather than bonds, companies can maintain a lower debt-to-equity ratio. This lower ratio can enhance their appeal to potential investors and reduce the burden of strict debt repayment schedules.
- Controlled Ownership: Preference shares allow companies to raise capital while limiting the influence of new investors on company control. Unlike common stocks, preferred shares do not usually come with voting rights, helping companies retain more control over their corporate governance.
Investor Benefits of Preference Shares
- Stable Dividend Payments: Preference shares are appealing to many investors due to their consistent and reliable dividend payments, which often exceed those of common Shares and are generally higher than bond interest payments.
- Flexibility in Dividend Payments: Companies can defer dividend payments on preference Shares during periods of financial difficulty or tight cash flow. This feature provides significant financial flexibility and helps companies manage cash flow challenges without the immediate repercussions of missing debt payments.
- Reduced Risk Compared to Bonds: Unlike bonds, which can lead to default, credit downgrades, or bankruptcy if payments are missed, preferred stocks offer a lower risk for companies. The ability to defer dividends helps mitigate financial strain without the severe consequences associated with defaulting on debt.
- Conversion Rights: Preference shareholders have the option to convert their shares into common stock at a predetermined exchange price. This potential upside can be advantageous if the company’s common stock performs well.
- Priority in Bankruptcy: In the event of bankruptcy, preference shareholders have priority over common shareholders when it comes to receiving any remaining company assets, offering an added layer of protection.
Overall, preferred stocks combine stable income with financial flexibility, making them an attractive investment choice for those seeking reliable returns and certain protective features.
Strategic Benefits of Preference Shares for Corporations
- Lower Debt-to-Equity Ratio: Issuing preference shares instead of bonds helps companies achieve a lower debt-to-equity ratio. This improved metric enhances the company’s ability to attract additional financing from new investors and signals a healthier balance sheet.
- Flexibility in Financial Obligations: Preference shares do not have the rigid repayment schedules that bonds do. This flexibility allows companies to manage financial obligations more effectively without the pressure of adhering to strict debt repayment requirements.
- Call Feature Advantage: Many preference shares are callable, enabling the issuer to repurchase them at par value after a certain date. This feature helps companies mitigate interest rate risk and take advantage of favorable market conditions, potentially avoiding opportunity costs.
- Control Retention: Unlike common stock, which grants voting rights and can shift control of the company, preference shares generally do not provide voting rights. This allows companies to raise equity capital while maintaining control over corporate governance.
- Defensive Mechanism: Preference shares can serve as a defense against hostile takeovers. Often including provisions known as “poison pills,” these shares can trigger financial penalties if a hostile party gains control, thereby protecting the company from unwanted acquisition attempts.
Unlocking the Process: Effective Procedures for Allotting Preference Shares
Filing with the Registrar of Companies (ROC) for the issue of preference shares involves several steps.
- Board Resolution
- Prepare a Board Resolution: The Board of Directors must pass a resolution approving the issuance of preference shares. This should include the number of shares, their face value, and other terms and conditions.
- Document the Resolution: Record the resolution in the minutes of the board meeting.
- Shareholders’ Approval
- Call an Extraordinary General Meeting (EGM): If required by the company’s Articles of Association or local laws, call an EGM to seek approval from the shareholders for the issue of preference shares.
- Pass a Special Resolution: The shareholders must pass a special resolution approving the issuance of preference shares.
- File with ROC
- Prepare the Necessary Documents: You will need to prepare and file the following documents with the ROC:
Form SH-7: For the alteration of share capital, if applicable.
Form MGT-14: To file the special resolution with the ROC.
Form PAS-3: For the return of allotment of shares.
- Upload the Documents: Log in to the Ministry of Corporate Affairs (MCA) portal and upload the filled forms along with the required attachments, such as the board resolution, special resolution, and any other relevant documents.
- Payment of Fees
- Pay the Filing Fees: Pay the requisite filing fees as per the ROC’s fee structure. The fee amount will depend on the type of forms and the number of shares issued.
- Verification and Acknowledgment
- ROC Scrutiny: The ROC will review the submitted documents. If everything is in order, they will process the forms.
- Receive Acknowledgment: You will receive an acknowledgment or a certificate from the ROC once the process is completed. This certificate confirms the registration of the preference shares.
- Update Company Records
- Update Share Register: Record the issuance of preference shares in the company’s share register.
- Issue Share Certificates: Prepare and issue share certificates to the new shareholders as evidence of their shareholding.
- Annual Compliance
- Include in Annual Return: Reflect the issue of preference shares in the company’s annual return and financial statements.
Preference shares offer a blend of financial flexibility, strategic advantages, and protective features, making them a valuable tool for companies aiming to optimize their capital structure and safeguard their corporate governance.
