To collect money, companies sell Preference Shares. Preference shares are considered a unique security since they combine the advantages of both debt and equity capital. Preference owners are therefore entitled to dividend payments ahead of ordinary shareholders. One disadvantage is that they do not have the same voting rights as common shareholders.
ADVANTAGES AND DISADVANTAGES OF PREFERENCE SHARES
Advantages of Preference Shares
1. Preference shares have pre-determined dividends that must be paid to
investors before dividends are distributed to ordinary shareholders. Although dividends are only paid when the corporation makes a profit, certain forms of preference shares (known as cumulative shares) allow unpaid dividends to accumulate. All unpaid dividends must be remitted to preference owners until the company is no longer in the debt before any dividends can be paid to ordinary shareholders.
2. Preference owners have a higher claim on company assets in the event of bankruptcy and liquidation, which allows preference shareholding appealing to investors with a low risk tolerance. The company promises a dividend every year, but if it fails to make a profit and has to close down, preference shareholders receive higher compensation.
3. Preference shareholders have the option of exchanging their shares for a set number of ordinary shares. If the company’s valuation and equity continue to rise, this may be a beneficial choice.
Disadvantages of Preference Shares
1. The dividend rate on preference shares is set at the time of purchase and remains constant until the shares mature, which can take up to 30 years. It might seem to be a better value when compared to current bond rates, but if market interest rates increase, the price of your preference shares may fall as other assets become more appealing. If you buy a 4-percentage-point
preferred and market rates rise to 6%, investors can sell your preferred and buy the new, higher-yielding alternative.