August 10, 2020


Accounting + Finance Blog

Preference shares: Meaning and key explanation

Preference shares: Meaning and key explanation

An uncommon or mostly theoretical type of share capital is preference shares. It is called so, because, in real life situation, you will not see any company that has utilized preference shares as a source of funding or investing. What does this type of shares mean? And what are the main points to note?

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Definition of preference shares

Preference shares can be defined in three ways

Definition base on dividend

Preference shares are the shares whose holders are entitled to a fixed dividend and who received dividends before ordinary shares.

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Definition base on voting right

Preference shares are shares whose holders do not have the right to vote at the annual general meeting of the company.

Definition base on liquidation

These are shares whose holders receive payment of their capital before ordinary shares in the event of winding up or liquidation of the company.

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Key explanations

Preference shares are also called preferred shares or preferred stocks. The alternative names are used mostly in the United States of America.

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Preference shares received dividends before ordinary shares. A company having a mixture of fixed capital (preference shares) and variable capital (that is, ordinary shares) pays the fixed capital before the variable capital. Therefore, holders’ preference shares received their dividend before holders of ordinary shares.

Preference shares receive a fixed dividend. The dividend given to preference shareholders is fixed. It is usually a fixed percentage, say 5%. The dividend rate is charged on the par value of the shares.

Preference shares are usually stated with a fixed percentage. Example, 100,000 10% preference shares at 2 Naira each.

This implies that the number of preference shares the company wants to sell is 100,000 shares. The nominal price or face value of the share is 2 Naira per share (that is, one share is 2 Naira). Therefore, the total value of shares is 200,000 Naira (that is, 2 Naira × 100,000).

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Also, the dividend for the share is 10 percent per annum. This is charged on the nominal or per value. The nominal value of the aforementioned company is 200,000 Naira. Therefore, the dividend to be paid to the preference shareholders is 20,000 Naira.

Preference shares cannot vote in the meetings of the company. This holder is not eligible for voting both at the annual general meeting and the extraordinary meetings of the company.

Preference shares can be bought back by the company. The directors may decide to buy back their preference shares from holders. This is usually done at a Call price. The excess of the call price over the par price is called the call premium.

Preference shareholders are given preference first at the liquidation of the company. If the company has reasons to fold up, the preference shares are paid first before the ordinary shares from the available assets of the company.

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To conclude, Preference shares are owned by preference shareholders. This class of shares is rear in the real world as most companies prefer to issue ordinary shares. In addition, the shares fall under fixed income investors as the dividend given to the holders is fixed year-to-year.

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