Today let’s talk about Preference Share Capital. As the name suggests, it’s called Preference Share Capital because it should be given preference. So, what does this preference mean?

Preference Share Capital is favoured in two key areas: dividends and the repayment of capital. Let’s break it down.

You can go click below for Video explanation or continue reading the blog.

Preference in Dividends

The first preference is for dividends. Whenever a company decides to distribute its profits as dividends, preference shareholders get their share before equity shareholders. Think of it like this: if the company has made a good profit over the year and decides to share it with its shareholders, the preference shareholders are first in line. The company will say, “Hold on, if we are going to give dividends to our shareholders, we must first give it to the preference shareholders.” Only after they are paid do the equity shareholders get their share. So, the first preference is always for dividends. When a company decides to distribute some of its profits, the preference shareholders get it first, then the equity shareholders.

Preference in Repayment of Capital

The second preference comes into play if the company shuts down. Let’s say the company goes out of business. What will they do? They’ll sell off all assets – land, buildings, machinery, everything. The money collected from these sales will be used to pay off debts, loans, and any liabilities, including government taxes. Once all these obligations are settled, the remaining money is used to pay back the shareholders. But remember, shareholders come in two types: preference and equity. So, who gets paid first? The preference shareholders. This is called the repayment of capital. If the company shuts down, preference shareholders get their money back before the equity shareholders.

Practical Example

Let’s simplify this with an example. Suppose a company has had a profitable year and wants to distribute dividends. The company will first distribute dividends to preference shareholders. Only after these shareholders have received their dividends will the remaining profits be shared with equity shareholders.

Similarly, if the company has to close down, it will first sell all its assets and settle all its liabilities. Once that’s done, the preference shareholders are the first to get their capital back. After paying them, whatever is left will be given to the equity shareholders.

Why Companies Issue Preference Shares

Why do companies issue preference shares? There are a few reasons:

• Raising Capital Without Losing Control: Issuing preference shares allows companies to raise money without giving up control, since preference shareholders usually don’t have voting rights.
• Attracting Investors: Preference shares attract investors who are looking for stable and prioritized dividend payments, making it an appealing option for those who want regular returns.
• Flexible Financial Structuring: Preference shares give companies a flexible tool to balance equity and debt-like features in their financial structure.

Conclusion

So, preference share capital is crucial for a company. It ensures that preference shareholders are given priority both in dividend distribution and in the repayment of capital. This makes it a blend of stability and security for investors.

In summary, preference share capital ensures that preference shareholders get paid first when it comes to dividends and capital repayment, offering them a safer and more secure investment compared to equity shareholders. This should make the meaning of Preference Share Capital clear.

 

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