Preference Shares

Preference shares are the shares which promise the holder a fixed dividend, whose payment takes priority over that of ordinary share dividends. Capital raised by the issue of preference shares is called preference share capital.

The preference shareholders are in superior position over equity shareholders in two ways:

  • First, receiving a fixed rate of dividend, out of the profits of the company, before any dividend is declared for equity shareholder and
  • Second, receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.


In short, the preference shareholders have a preferential claim over dividend and repayment of capital as compared to equity shareholders.

Dividends are payable only at the discretion of the directors and only out of profit after tax, to that extent, these resemble equity shares.

Preference resembles debentures as both bear fixed rate of return to the holder. Thus, preference shares have some characteristics of both equity shares and debentures.

Preference shareholders generally do not enjoy any voting rights. In certain cases, holders of preference shares may claim voting rights if the dividends are not paid for two years or more on cumulative preference shares and three years or more on non-cumulative preference shares.

What are cumulative and non-cumulative preference shares? They are classified below:

Types of Preference Shares

  • 1. Cumulative and Non-Cumulative: The preference shares that have the right to collect unpaid dividends in the future years, in case the same is not paid during a year are known as cumulative preference shares. Non-cumulative shares, the dividend are not accumulated if it is not paid in a particular year.

  • 2. Convertible and Non-Convertible: Preference shares that can be converted into equity shares within a specified period of time are known as convertible preference shares. Non-convertible shares are those which cannot be converted into equity shares.

    Let’s summarise about preference share in context of Investors-

    • a. The rate of dividend on preference shares is generally higher than the rate of interest on debentures
    • b. Fixed rate of dividend, out of the profits of the company, before any dividend is declared for equity shareholder. i.e. preference shareholders are given preference over equity shareholders.
    • c. At the time of liquidation of company, preference shareholder will receive share in assets of the company before paying to equity shareholders.

Let’s understand with Example-

Example-1:

: Non- Convertible non-Cumulative Preference share :
HBF Direct Ltd issued non- Convertible non-Cumulative Preference share. of Rs. 10,00,000( 100,000 preference shares @ Rs. 10 each)@12% annual dividend redeemable at the end of 5th year.

Case-1:
Regular Dividend paid by company

HBF direct will pay Rs. 1,20,000 every year to investor and at the end of 5th year, company will pay original invested amount of Rs. 10,00,000 also.
Hence, Investor will earn Rs. 1, 20, 000*5= Rs.6, 00,000 divided over the period of 5 Years if company pays dividend regularly.

Case-2:
Regular Dividend not paid by company.

Suppose if out of 5 years, company pays dividend only in first 3 years then Investor will earn Rs.1,20,000*3= Rs. 3,60,000 and at the end of 5th year original invested capital of Rs, 10,00,000 shall also be returned to investor.


In case of non-cumulative preference share, if company fails to pay dividend then dividend will not be cumulated i.e. shall not be carried forwarded to next year. However, if company has sufficient profit/reserve then company can pay on voluntary basis

In case of non- convertible preference share, company will redeem the amount and investors are not eligible to get its preference share converted into equity share.

Let’s understand with Example-

Example-2:

Non- Convertible Cumulative Preference share :
HBF Direct Ltd issued non- Convertible Cumulative Preference share. of Rs. 10,00,000 ( 1,00,000 preference share @ Rs. 10 each) @12% annual dividend redeemable at the end of 5th year

Case-1:
Regular Dividend paid by company

HBF direct will pay Rs. 1,20,000 every year to investor and at the end of 5th year, company will pay original invested amount of Rs. 10,00,000 also.
Hence, Investor will earn Rs. 1, 20, 000*5= Rs.6, 00,000 divided over the period of 5 Years if company pays dividend regularly.





Case-2:
Regular Dividend not paid by company

Suppose if Company does not pay dividend in first 2 years then dividend of Rs. 1,20,000*2 =Rs. 2,40,000 will be carried forwarded to 3rd year and it shall be paid along with 3rd year dividend. i.e. Investor will get cumulative amount of Rs. 3,60,000( 1,20,000*3) in 3rd year and at the end of 5th year original invested capital of Rs, 10,00,000 shall be returned to investor.
Hence, Investor will earn Rs. 1, 20, 000*5= Rs.6, 00,000 divided over the period of 5 Years even if company does not pay dividend regularly as per above example.

In case of non- convertible preference share, company will redeem the amount and investors are not eligible to get its preference share converted into equity share.

In case of cumulative preference share, if company fails to pay dividend in any year then that unpaid dividend shall be carried forward to next year and is paid along with subsequent dividend.

Let’s understand with Example-

Example-3:

Convertible non-Cumulative Preference share :
HBF Direct Ltd issued Convertible non-Cumulative Preference share. of Rs. 10,00,000(100000 preference share @ Rs. 10 each) @12% annual dividend convertible at the end of 5th year (Swap Ratio- 1: 100) i.e 1 equity share for 100 preference share.

Case-1:
Regular Dividend paid by company

HBF direct will pay Rs. 1,20,000 every year to investor and at the end of 5th year.
Moreover, investor will get 1000 equity shares.
Hence, Investor will earn Rs. 1, 20, 000*5= Rs.6, 00,000 divided over the period of 5 Years if company pays dividend regularly and at the end of 5th year 1000 equity share irrespective of market price of equity share.

Case-2:
Regular Dividend not paid by company

Suppose if out of 5 years, company pays dividend only in first 3 years then Investor will earn Rs.1,20,000*3= Rs. 3,60,000 and at the end of 5th year 1000 equity share irrespective of market price of equity share.



In case of non-cumulative preference share, if company fails to pay dividend then dividend will not be cumulated i.e. shall not be carried forwarded to next year. However, if company has sufficient profit/reserve then company can pay on voluntary basis.
In case of convertible preference share, preference share shall be converted into equity share in swap ratio.

Let’s understand with Example-

Example-4:

Convertible Cumulative Preference share :
HBF Direct Ltd issued Convertible Cumulative Preference share. of Rs. 10,00,000(100000 preference share @ Rs. 10 each) @12% annual dividend convertible at the end of 5th year (Swap Ratio- 1: 100) i.e. 1 equity share for 100 preference share.

Case-1:
Regular Dividend paid by company

HBF direct will pay Rs. 1, 20,000 every year to investor and at the end of 5th year investor will get 1000 equity shares

Hence, Investor will earn Rs. 1, 20, 000*5= Rs.6, 00,000 divided over the period of 5 Years if company pays dividend regularly and at the end of 5th year, 1000 equity share irrespective of market price of equity share.






Case-2:
Regular Dividend not paid by company.

Suppose if Company does not pay dividend in first 2 years then dividend of Rs. 1,20,000*2 =Rs. 2,40,000 will be carried forwarded to 3rd year and it shall be paid along with 3rd year dividend. i.e. Investor will get cumulative amount of Rs. 3,60,000( 1,20,000*3) in 3rd year and at the end of 5th year 1000 equity share irrespective of market price of equity share.
Hence, Investor will earn Rs. 1, 20, 000*5= Rs.6, 00,000 divided over the period of 5 Years even if company does not pay dividend regularly as per above example and 1000 equity share irrespective of market price of equity share.

In case of cumulative preference share, if company fails to pay dividend then dividend shall be cumulated i.e shall be carried forwarded to next year.

In case of convertible preference share, preference share shall be converted into equity share in swap ratio.