January 29, 2022

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Meaning of Redeemable Preference Shares with Key Explanations

Meaning of Redeemable Preference Shares with Key Explanations
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Preference shares can be in several forms. This depends on the purpose of such shares. And the decision of the board of directors. For redeemable preference shares, the aim is to redeem or call back the shares.

What are redeemable preference shares?

A type of preference shares where the issuing company has the right to redeem the shares at any time or a date agreed by the Board of Directors.

It can also be defined as shares with callable options upon the board of directors’ decision.

Key Explanations

These shares have similar features with other preference shares. It attributes are:

Fixed dividend. The dividend is fixed. For example, a 6% 10000 redeemable preference shares @ N1 each. The coupon rate is 6 per cent. Meaning the entity can pay a total of 600 Naira as a dividend. This means that 600 Naira will be paid every year by the issuing company.

Voting rights. The shareholders have no voting right. Unlike ordinary shares that make major decisions for the company, redeemable shares have no such rights. In the meetings of the shareholders and the board members, this type of stock cannot make any meaningful contribution since it cannot vote to support or oppose any decision.

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On liquidation, its shares are repaid before ordinary shares. Truly, when the need arises to liquidate the company, preference shareholders are paid before ordinary shareholders.

Unique features of redeemable preferred shares

Aside, having similarities with other stock, redeemable preference shares are unique in their ways.

It can be redeemed at any time by the decision of the board of directors. The top management might decide to call the shares at its discretion. However, if the shares when it was available for sale was not stated as redeemable, it cannot have callable options. This means that a cumulative preferred stock cannot be redeemed.

It has both callable and repurchased options. A redeemable preference share can either be redeemed or repurchased. This depends on the decision of the Board. It is best to call back the stock if the par value is less than the market value. The par value is the amount stated at the face of the shares. A 6% 10,000 redeemable preference shares @ N1 each has a par value of N1. However, its market value, that is, the price at which shareholders are willing and able to buy and sell might be different from the par value.

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If the par value is 10 Naira and the market value is 8 Naira. The board of directors can decide to redeem the shares at 9 Naira or an amount slightly above the par value, say 10.50 Naira. However, if the market value is higher, say 14 Naira per share, the top management will not be able to call back the shares. This is because the issuing company will pay a higher amount than the par value. Therefore, the issuer wouldn’t redeem it.

Besides, Venture capital firms may decide to invest in an equity company through redeemable preference shares. Especially, if the capitalist decides to exit the company at an agreed date. The callable option is better as it gives the holder the right to capital gains at the time the shares are redeemed.

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When redeemable preferred shares are called, the issuing company cash position reduces. However, the shareholders’ return on investment (ROI) increases as well as their earnings per share (EPS). How? If the Earning for the year is 20 million, and the total shares are 10 million. The EPS will be 2 Naira per share (20 ÷ 10). But when part of the shares is redeemed, say 2 million shares. The remaining shares will be 8 million and the EPS is 2.5 Naira per share (20 ÷ 8).

Conclusion

Unlike other preference shares, these shares can be redeemed at the convenience of the Board of Directors or at any other time agreed by both the issuer and shareholders. Also, the maximum number of years the redeemable preference shares can remain unredeemed is 20 years.

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