Companies may generally offer two types of shares − ordinary shares and preference shares. Preference shares have preference over ordinary shares in terms of payment of dividends and returning the capital in case the company wounds up. The capital offered by preference shares is known as share capital. Preference shares are a favorite of long-term investors.
Note − The two types of shares have some common features but in general, their differences are more than the similarities.
Preference Shares can be grouped into three different categories −
Redeemable and Irredeemable Preference Shares
Cumulative and Non-Cumulative Preference Shares
Participative and Non-Participative Preference Shares
Redeemable Preference Shares are also known as Callable Preference Shares and are one of the most common ways to finance big companies. They usually come with a mix of equity and debt and are readily traded on the stock exchanges. The issuers of these shares can buy these shares back for ownership issues. The redeemable shares are therefore re-purchased on a given date previously announced by the company. Redeemable preference shares are handy in case of inflation and down-gradation of monetary rates.
Irredeemable Preference Shares are irredeemable during the lifetime of a company and they pay dividends only during the lifetime of the issuing company. The investors in such shares, therefore need to wait for the company to wound up to get the capital back. It makes the shares a liability forever for the company.
Cumulative shares offer shareholders the option to achieve dividends in cumulative terms. If a company fails to pay the dividends according to its mention during the issuance of the bonds, the company will provide lower dividends during the time of stress but as soon as the condition comes back on track, the cumulative dividends are paid back to investors.
In case of non-cumulative preference shares, the company does not provide dividends from its profits even if it fails once to offer dividends earlier. Non-cumulative stocks generally offer the dividends in fixed durations but on failing for which, it may pay lesser dividends without any possibility of paying the dividends back in the future.
Participative shares allow partaking in surplus profit while in liquidation once the given company has paid the outstanding shareholders. So, the shareholders receive a participative dividend and also the position of fixed dividend from shares. Most investors invest in participative preference shares when they have the opportunity of making huge profits.
Note − Participative shares offer a portion of dividends to the shareholders when it earns an extra profit.
In case of non-participative preference shares, the shareholders do not get anything even when the company makes extra profits. They only get the pre-fixed amount via dividends of the shares as usual.