Preference shares are a part of the equity of a company. These shares entitle the shareholders to get a dividend at a fixed rate and are paid before paying to the ordinary shareholders. The risk involved in investing in preference shares is less as compared to ordinary shares as, in case if a company liquidates, the preference shareholders will be given a preference over ordinary shareholders at the time of repayment. However, one major limitation of these shares is that, it does not give any voting rights to the shareholders. Therefore, they cannot have any say in a company's decision-making.
Using permutations and combination to the above mentioned features of preference shares the following types can be formed.
Fixed-Rate Hard Retractable
Fixed-rate retractable preference shares are those shares that have a fixed rate of dividend, paid at specific periods. These shares have a fixed maturity rate. These shareholders have to be repaid 'In Cash' after the maturity period.
In case of soft-retractable preference shares, the shareholder gets fixed dividends and at maturity, gets an option to retract either in cash or in stock at 95% of the weighted average trading range over the former 20 days.
Floating rate retractable preference shareholders get a dividend based on the current market rate. They are repayable on the date of maturity in the form of cash.
Fixed-Rate Perpetual (Straight)
Fixed rate perpetual preference shares are those shares which do not have a fixed maturity date. A shareholder will keep receiving dividends at a fixed rate, forever or till the firm liquidates or at his will.
Floating-rate perpetual preference shareholders receive dividends or returns based on the current market interest rate. Again, there is no maturity date fixed and the shareholder keeps receiving dividends, either till the firm liquidates or forever.
Fixed floating preference shares have similar characteristics as the perpetual shares. The maturity date of the fixed floating preference shares is perpetual but the rate of dividend is modified after every five years. The dividend rates are set up at a fixed percentage plus a rate that is higher than that of the 3 month treasury bill or the five year government bond.
Split and Structured Preferred Shares
Split and structured preferred shares are also known as Synthetic Preference Shares. These shares have a fixed maturity period and have been proven as an efficient tool for steady income. As the term indicates, these preference shares are not based on the preference shares alone. They are based on a portfolio of diverse and complex financial instruments or even a portfolio of ordinary shares. Split shares are considered as less risky because of its diversity in returns.
Convertible Preference Shares
They are those shares that can be converted into ordinary equity shares. This is an add-on option given to the shareholder; and he opts to convert his shares only if he feels that it is going to give him more benefit.
Non-convertible Preference Shares
They do not give the investors an option to convert his shares into equity shares.
Participating Preference Shares
Participating preference shareholders get an added right to receive the remaining profit, which is left after paying-off returns to all the other investors. A participating preference shareholder therefore, gets dividend plus a share in the surplus profit, if any, as a return.
Non-Participating Preference Shares
Most of the shares are non-participating preference shares. If a preference share does not give you the right to receive a share from the company's surplus, then it is termed as a non-participating preference share.
A cumulative preference share gives the right to the shareholders to receive 'arrears of dividend' from the past years. This type of preference shares have less risk involved in it and would generally have a fixed rate of dividend. An investor here is more secured about his returns.
Non-cumulative preference shares do not give a shareholder the right to get his past arrears of dividend. Therefore, if a company has not made any profit, the investor will not get dividend for all those years.
All the preference shareholders are to be paid before paying off the equity shareholders. Shareholders are to be paid out of the net profit of company or amount received by issuing new shares, which infers that they cannot be repaid by taking a loan.
Preference shares are widely used investment instruments by investors, as it has less risk associated with it. A preferred stock gives you better returns than a common stock. Knowing the different types of preference shares will help you understand, which one you should invest in to maximize returns.