Preference shares are also known as preferred stock and are a shareholding in the company’s stock for which a preference dividend can be earned before the dividend on equity stocks is issued to the shareholders of such equity stock. In case a company goes into liquidation, the preference shareholders will be entitled to be paid from the company’s assets before the equity shareholders.
Most preference shares hold a fixed dividend, unlike equity shares. Regarding voting rights, they would not be enjoyed by preference holders like the equity shareholders of the company. These are generally classified as the following:
- Cumulative Preference Shares,
- Non-Cumulative Preference Shares,
- Participating Preference Shares and
- Convertible Preference Shares
Let’s understand each of the above in detail:
Cumulative Preference Shares
Cumulative preference shares can be understood as those that require the company to pay shareholders all dividends, including those that were omitted during the past years or several years, even before the equity shareholders are paid any dividend thereof. The payment of dividends on cumulative preference shares is guaranteed but would necessarily not be paid immediately on the date they are due.
Non-Cumulative Preference Shares
At the same time, in this type of preference share, the omitted or unpaid dividends of past years would not be paid. Hence, it is completely under the company’s discretion to make decisions regarding the payment and non-payment of any such unpaid or omitted dividends of past years to these preference shareholders.
Participating Preference Shares
In this type of preference share, the shareholders will be entitled to dividend payout in an amount equal to the generally specified rate of preferred dividends plus an additional dividend, which will be based on a condition that is pre-determined. Such additional dividends shall be paid, or the preference shareholders holding participating preference shares shall become entitled to the same if dividends received by common or equity shareholders are greater than a predetermined per-share amount.
Convertible Preference Shares
Here, the shareholders can convert their preferred shares into a defined number of equity shares. This can generally be done after a definite pre-established period. In the case of convertible preference shares, these shares are exchanged at the request of the shareholder. Companies also hold provisions on such shares, which would allow the issuer to force such issue or conversion. The value of this shall ultimately be determined based on the performance of the company’s equity shares.
Preferential Issue
Preferential Issue of shares can be understood as the procedure of issuing a large number of fresh shares to a specific group of individuals. This group will include venture capitalists, other companies, or any other persons who need to raise funds. It is otherwise referred to as preferential allotment of shares.
Hence, a preferential issue or allotment is the issue of shares or convertible securities by listed or unlisted or public or such other companies to a selected group of investors but, at the same time, is not a rights issue or public issue. The rights issue is nothing but the rights given to existing shareholders to purchase additional shares. In contrast, public issues are the method used to raise share capital by selling securities to the public.
As per the Companies Act, shares or other securities shall include equity shares, fully convertible debentures, partly convertible debentures, or such other securities that would be convertible into or can be exchanged with the company’s equity shares at a later stage.
Usually, companies adopt preferential allotment as it is an easy and fastest means for increasing share capital and bringing capital into the entity. The allotters here become the shareholders of the company. They would now be considered the company’s owned fund rather than any loan taken from banks or financial institutions. Companies like public, private, listed, unlisted or section 8 companies and other companies can make preferential allotments or issues.
Here, the allotment should be made to persons who are given preference by the company over its existing shareholders. This will increase the number of shareholders in the company.
Difference Between Preference Shares and Preferential Allotment
Based on our understanding of preference shares and preferential allotment, we can say that they do not have any direct connection. Preference shares are nothing but securities like equity shares issued by companies to the public or a mass for raising capital. The reward for them is paid in the form of dividends.
At the same time, preferential allotment is a process of issuing securities to certain preferred, specific groups who are not existing shareholders of the company necessarily to raise capital faster. This will include preference shares, equity shares, debentures, and other securities that can be converted into or exchanged with the equity shares of the company at a later stage.
Hence, we can conclude that both these concepts are different when taken from the ambit of a company and share allotment, except that preference shares can be issued through preferential allotment by a company.
