Question

Answer the following question.

Define preference shares. What are the different types of preference shares?

What are Preference Shares? Explain its types.

Answer 1

As the name indicates, these shares have certain privileges and preferential rights distinct from those attached to equity shares. The shares which carry the following preferential rights are termed preference shares.

1. A preferential right as to the payment of dividends during the lifetime of the company.
2. A preferential right as to the return of capital in the event of winding up of the company.

1. Cumulative preference shares:
Cumulative preference shares are those shares on which a dividend goes on accumulating until it is fully paid. This means, if the dividend is not paid in one or more years due to inadequate profit, then such unpaid dividend gets accumulated. The accumulated dividend is paid when the company performs well. The arrears of dividends are paid before making payment to equity shareholders The preference shares are always cumulative unless otherwise stated in the Articles of Association. It means that if the dividend is not paid in any year or falls short of the prescribed rate, the unpaid amount is carried forward to next year, and so on until all arrears have been paid.

2. Non-cumulative preference shares:
The dividend on these shares does not accumulate. This means the dividend on shares can be paid only out of profits of that year. The right to claim dividends will lapse if the company does not make a profit in that particular year. If the dividend is not paid in any year, it is lost.

3. Participating preference shares:
The holders of these shares are entitled to participate in surplus profit besides preferential dividends. The surplus profit which remains after the dividend has been paid to equity shareholders up to a certain limit is distributed to preference shareholders.

4. Non-participating preference shares:
The preference shares are deemed to be non-participating if there is no clear provision in the Articles of Association. These shareholders are entitled only to a fixed rate of a dividend prescribed in the issue.

5. Convertible preference shares:
These shareholders have a right to convert their preference shares into equity shares. The conversion takes place within a certain fixed period.

6. Non-convertible preference shares:
These shares cannot be converted into equity shares.

7. Redeemable preference shares:
Shares that can be redeemed after a certain fixed period are called redeemable preference shares. A company limited by shares, if authorized by Articles of Association, issues redeemable preference shares. Such shares must be fully paid. These shares are redeemed out of divisible profit only or out of a fresh issue of shares made for this purpose.

8. Irredeemable preference shares:
Shares that are not redeemable i.e. payable only on the winding up of the company are called irredeemable preference shares. As per the Companies Act (Amendment made in 1988), the company can not issue irredeemable preference shares.