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Preference Shares (Investor advantages (Usually provide higher returns…
Preference Shares
Investor advantages
Usually provide higher returns than bonds issued by the same company and there is generally less risk than with ordinary shares in the company
Receive a fixed percentage of the nominal amount annually. This dividend must be paid before the ordinary share dividend. There is no need for the investors to wait for the director's announcement to ascertain the amount of the dividend because it is known from the outset
Even if no ordinary share dividend is declared, the preference share dividend should be paid, because non-payment will be viewed very unfavourably in the markets
Upon liquidation, preference shareholders rank above the ordinary shareholders for return of capital and current and accrued dividend payments
Upon liquidation, investors will receive only the nominal amount rather than a market price, because that is the liability of the company. If preference shares were purchased below par, the investor will make a capital gain
The preference share dividend is paid out of post tax company profits and is thus franked investment income
Issuer advantages
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Dividend payment may be suspended if the company has not earned sufficient profits to finance the dividend. This may be detrimental rather than fatal. If ban loan or bond interest payments are missed, the company may be forced into administration by its creditors
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If the preference shares are non-cumulative, arrears of dividends do not have to be paid to the preference shareholders
Do not ordinarily carry rights to profits beyond the fixed entitlement to receive any capital surpluses beyond the nominal amount of the share
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Investor disadvantages
Preference shareholders are members of the company but they generally have no right to vote or attend AGMs unless dividends of cumulative preference shares are in arrears
Unless the preference shares are participating preference shares, the preference shareholder will only ever receive a fixed percentage of the nominal value, even if a company performs extremely well
Upon liquidation, investors will receive only the nominal amount. If shares were purchased above par the investor will make a capital loss
Issuer disadvantages
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If profits are reduced, the issuer may still be obliged to make the fixed dividend payment
The payment of preference shares dividend is not tax deductible as is the case with debt interest payments
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Often likened to debt but legally classed as share capital and as such are treated for tax purposes in the same manner as ordinary shares
The terms of issue for, and characteristics of, preference shares are usually explained in detail within a company's articles of associations
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Used by companies usually financial institutions as a means to obtain external finance without having to relinquish any control of the company
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Preference shares were traditionally purchased by institutional investors however they may also be used by private investors focused on income rather than capital gains
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If default ensues in relation to the dividend payment, the preference shareholders cannot force the company not liquidation