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Pros and Cons of Preference Shares

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Publish Date: December 05th, 2019

By: Sandhya Kannan, Head – Content

Share trading is popularly known as preference shares or preferred stock which is different from common stock These types of shares seem to have both a positive impact and negative connotations in relation to the issuing companies and their investors.

Preference shares are a mode for companies to raise capital on a regular basis. Considered as a form of hybrid security, preference shares have a number of advantages and disadvantages associated with it. They are as follows:

Benefits of Preference Shares

1.   Dividends are paid first to preference shareholders
The primary advantage for shareholders is that the preference shares have a fixed dividend. This payout is typically done prior to any dividends being paid to common shareholders. If the company turns a profit, the dividends are paid on some types of preference shares. This generally permits for the aggregation of dividends that are unpaid. The preferred shareholders get priority when it comes to remitting unpaid dividends, over common shareholders.

2.   Preference shareholders have a prior claim on business assets
If the business decides to file for bankruptcy or liquidates, preference shareholders can stake a higher claim on the assets of the business. This makes the risk of investment tolerable as opposed to the common shareholder. The preferred shareholders have a guaranteed dividend payout annually. In fact, if the business does opt to shut down its operations, the preferred shareholders will be adequately compensated for their investments.

3.   Add-on Benefits for Investors
With preference shares, shareholders are allowed to trade in their convertible shares for a pre-decided number of common shares. If the company is able to meet a specified profit mark that was determined earlier, then the shareholder has the opportunity to experience add-on dividends. This can be an advantageous prospect, especially if the value of common shares starts increasing. In order to generate long-term income, this particular segment of preference shares are low risk and offer additional benefits as a type of investment instrument.

Disadvantages of Preference Shares

1.   There are no voting rights for preference investors
The key disadvantage of owning preferred shares is the absence of ownership rights in the business. From an investor perspective, the business is not liable to preferred shareholders as opposed to equity shareholders. If the business really turns a profit and the interest rate increases, the preferred shareholders will be stuck on the fixed dividend.

2.   Higher cost than debt for issuing company
In order to finance projects, businesses will try to raise capital through debt and equity issues which are basically costs associated with operations. Usually, large corporations issue preferred stock to the public in addition to raising funds through the common stock and corporate bonds. Businesses that choose equity in place of debt issues are able to attain a lower debt to equity ratio. This offers them a significant benefit in terms of leveraging for additional financing from new investors.