Preference shares - overview, risks and alternatives

Summary

Preference shares are a class of shares that give holders certain advantages or different rights over ordinary shareholders. Most early-stage companies begin with only ordinary shares, held by founders and early employees. They tend to avoid issuing preference shares at the beginning because doing so adds legal complexity and reduces founder control. Ordinary shares (or common shares) represent ownership in a company and typically come with voting rights. This means shareholders can vote on important matters like electing board members or approving major decisions. Dividends for ordinary shareholders are not guaranteed — they are only paid if the company chooses to distribute profits and only after preference shareholders have been paid. In the event of liquidation (if the company is shut down and its assets are sold), ordinary shareholders are the last to be paid, after all debts and preference shares. This makes ordinary shares riskier but with greater potential for reward if the company grows and its value increases. Preference shares, in contrast, usually do not have voting rights, but they come with preferential treatment when it comes to dividends and liquidation. They often.

Key information

• Raising capital \- companies can issue preference shares to attract a specific type of investor who prioritises fixed income over capital growth.
• Employee incentives \- offering employees preference shares can be a retention tool and reward their loyalty.
• Acquisitions and financing \- preference shares can be used in complex finance structures or as part of acquisition deals.
• Family Succession Planning - balancing inheritance while maintaining voting control.
• Restructuring - converting debt to equity without diluting management control.
• Participatory preference shares \- holders receive a fixed annual dividend and may also benefit from additional payouts when the company surpasses certain performance benchmarks. This is perhaps the most commonly used type of preference share as it is simple to use, administer, and implement.
• Redeemable preference shares \- issued with a predetermined redemption period, after which the company repurchases them from shareholders based on the share value at redemption. This type of preference share is very useful as it allows for the share to be redeemed once the shareholder has received a certain amount as a dividend, thereby not interfering with the company’s shareholding structure.
• Cumulative preference shares \- if a dividend payment is missed, it carries forward to the next payment cycle. When dividends are eventually paid, shareholders receive both the current and any previously unpaid amounts. If dividends remain unpaid for multiple cycles, they continue accumulating until payment is made.
• Non-cumulative preference shares \- if the company decides to skip a dividend payment, the shareholder forfeits that payment permanently and cannot claim it in the future.
• Convertible Preference shares \- these shares allow holders to convert their preference shares into ordinary shares at specific intervals based on agreed terms. After conversion, shareholders gain voting rights.
• Dilution of voting power \- issuing preference shares can dilute the voting power of existing ordinary shareholders.
• Dividend payments \- preference dividends must be paid before ordinary dividends, impacting the amount available for distribution to ordinary shareholders.

Practical guidance

• Source: Preference shares - overview, risks and alternatives

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