Companies could issue preference shares to their shareholders. These are special shares which give the shareholder certain rights. Those who hold preference shares of a company are paid fixed rate of dividend before the dividend is paid to the equity shareholders.
Theother advantage of having preference sharesis that in case a company winds up then the capital is first paid to the preference shareholders before the equity capital is returned. The preference shareholders do not have any voting rights but they can claim voting rights in case the company does not pay dividends for two years or more. This is two or more years in the cumulative preference shares and three years or more in the case of a non-cumulative preference share.
Thepreference shareshave the characteristics of debentures as well asequity shares. Thedividends on the preference shares will bepaid only when the company declares profits. This is like the equity shares. This is solely at the discretion of the board of directors.
Thepreference shares are very similar to debentures. This is because in both cases the rate of dividend is fixed and also because like debentures the preference shareholders do not have anyvoting rights. This is the reasonwhy a preference share is like a hybrid form of financing a company.
Advantages of issuing preference shares
The preference shares can be sold to those investors who want to protecttheir capital and they want a regular fixed return on their investment. There is no obligation on the company to pay dividends. This is because a company does not have to pay dividends to the preference shareholders in case they do not make sufficient profits. They can postpone paying the dividends in the case of a cumulative preference share. There is no fixed burden on the company andthus preference shares are highly beneficial for the companies to issue.
The preference shareholders do not have anyvotingrights,find out more, and thus a company can easilyraise capital without any external control. The equity shareholders on the other hand will have a lot of control on the decision made by the company.
The dividend paid on the preference shares is fixed and thus in case of an increase in earnings the company could provide trading on equity benefit to the equity shareholders. The preference shareholders also do not charge or have any mortgage on the companyassets and thus the company has full control on its assets in case it wants to raise any loan.