PREFERENCE SHARES

Not all shares are created equally. What makes preference shares different?

What distinguishes ordinary shares from preference shares?

1. Voting rights
2. Preferential status in relation to the payment of dividends and the return of capital
3. The obligation to comply with the provisions of a companys memorandum of incorporation or MOI

Ordinary shares

Companies can have both ordinary shares and preference shares. Ordinary shares are the most common type of shares traded on any exchange.

 

The good and the bad:

1. Ordinary Shares give you full voting rights at annual general meetings. One share, one vote.
2. You may receive dividends. Dividends are not fixed, so it can be higher or lower than the preference shareholders dividends. Ordinary shareholders may not receive dividend payments every year, and payments to ordinary shareholders depend on reinvestment decisions made by the company directors.
3. Ordinary shares allow you to benefit from capital growth should the company do well.
4. In an event of the company facing liquidation, the ordinary shareholders will be the last to receive their share of funds, after the creditors and preference shareholders are paid. Shareholders are the owners, so they are last in line to receive anything in the event of liquidation.

Preference shares

Preference shares are shares that have some of the characteristics of debt and equity. They behave like shares in that their prices can climb over time as they are traded but are similar to debt because they pay investors fixed returns in the form of dividends. Prices seldom move significantly for preference shares, as their value is simply linked to supply and demand, not the underlying growth in the business.

The good and the bad:

1. Preference shareholders do not have the right to vote at annual general meetings.
2. Preference shareholders have a better chance of receiving dividends than ordinary shareholders, although preference shareholders are not guaranteed dividend payments if the company makes losses.
3. Preference shareholders are however guaranteed a specified percentage of dividends if the company makes a profit.
4. Preference shareholders are second in line to receive their capital back after debt holders (the banks) if the company is wound up.

Considerations for every investor

1. Consider how important voting rights are to you.
2. How important is guaranteed dividends to you should the company make profits?
3. Are you comfortable with minimal capital growth?
4. Always remember the hierarchy if things go wrong. Banks first, then preference shareholders and lastly the ordinary shareholders.