Preference shares are a class of company shares that have a priority over ordinary shares in terms of receiving dividends and other distributions.
Advantages of Preference Shares
Priority in Dividend Payments
Preference shareholders are entitled to receive a fixed dividend payment before the company pays any dividends to ordinary shareholders. This gives preference shareholders a more predictable return on investment and, therefore, is attractive to investors.
As preference shares have a fixed dividend payment structure, they are typically less volatile than ordinary shares, which can be affected by changes in the company’s value. This can make preference shares a more stable investment option for investors looking to reduce their overall risk exposure.
Some preference shares have the potential for capital appreciation if the company performs well, which provides investors with the benefit of a capital gain in addition to their dividend income.
Unlike issuing new ordinary shares, which can dilute existing shareholders’ ownership stake, issuing preference shares does not always dilute the ownership of ordinary shareholders. As a result, this can be a valuable way for a company to raise additional capital without affecting its existing shareholders’ voting power or control.
Overall, preference shares can be a valuable tool for companies to raise capital and for investors to receive a more predictable income stream with less volatility than ordinary shares.
How preference shares can potentially dilute ordinary shareholders and other preference shareholders.
When a company issues preference shares, it can dilute existing shareholders’ ownership stake, including ordinary shareholders. This is because preference shares typically have priority over ordinary shares in terms of receiving dividends and other distributions from the company.
However, the extent to which preference shares dilute existing shareholders’ ownership stake depends on the preference shares’ terms. For example, suppose the preference shares have a high fixed dividend rate or are convertible to ordinary shares at a favourable ratio. In that case, this can increase the potential dilution of existing shareholders.
On the other hand, if the preference shares have lower fixed dividend payments or are redeemable at a premium to the issue price, this can reduce the potential dilution of existing shareholders.
It’s also worth noting that preference shares can impact the dilution of other preference shareholders. For example, if a company issues additional preference shares with higher dividend rates than existing preference shares, this can dilute the ownership stake and dividend payments of existing preference shareholders.
In summary, preference shares can impact the dilution of ordinary and other preference shareholders, depending on the terms of the preference shares. It’s essential for companies to carefully consider the potential impact on existing shareholders when issuing preference shares and to have a clear plan in place for managing the business’s ownership structure.
Related: Shareholders Agreement Guide.