The terminology around investing can be confusing, but we’re here to help. Let’s break down what preference shares are and how they differ from ordinary shares. We’ll also take a look at a few other things you need to be aware of.
What are preference shares?
Preference shares are shares paid by a company to shareholders before ordinary shares. Basically, preference shareholders move to the front of the queue when it’s time for dividends to be paid. Meanwhile, if the company goes bankrupt, then these shares are paid before any other type of stock.
Sounds great right? It can be, but the quid pro quo is that preference shareholders have no voting rights. And while they provide a steady fixed income, these shares don’t benefit from any increase in the share price.
What are ordinary shares?
When we think of traditional stock, we ` think of ordinary shares. Typically, ordinary shareholders get to vote in a company’s major decisions.
However, as an ordinary shareholder, you may or may not receive a dividend. Preference shareholders are the priority.
Just to clear things up further, a dividend is the stock owner’s share of the profits of the company over the past quarter of the year. So if the company hasn’t made much profit, it may not have anything to pay ordinary shareholders.
Are there different types?
There are different types of preferred shares. Let’s take a look:
Cumulative
Cumulative preference shareholders have the right to dividends that may have been missed in the past.
Basically, if a company stops or reduces a preference shareholder’s dividends, then when they start back up again, cumulative shareholders are first in line to receive the dividends in arrears.
Participating
If having preference shares puts you at the front of the queue, then participating preference shares put you right at the top of the list.
When a liquidation event happens, preference shares are paid first. If there is enough money to pay preference shareholders and ordinary shareholders, then participating preference shareholders get a share of any remaining proceeds at a specified rate.
If you have non-participating preference shares then you will receive your liquidation value and any dividends in arrears, but you will not be entitled to anything else.
Convertible
Convertible preference shares include the option to convert shares into a fixed number of ordinary shares after a certain date.
Their different structures mean that preference and ordinary shares trade at different prices. Typically preference shares don’t benefit from increases in dividend payments or the share price.
That is unless they are convertible preference shares. In exchange for a lower dividend, this type of share gives shareholders the ability to participate in share price appreciation.
Takeaway
The big advantage of preference shares is that they provide a steady fixed income which is guaranteed to be paid ahead of ordinary shares. However, preference shareholders have no say in big company decisions and they can’t benefit from any increases in the share price.
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