Preference shares pay a fixed dividend and rank ahead of equity shares if a company is wound up. They usually carry no vote. The main types are cumulative and non-cumulative, participating and non-participating, convertible and non-convertible, and redeemable and irredeemable. Under the Companies Act 2013, Indian companies may issue only redeemable preference shares. They must be repaid within 20 years, or 30 years for infrastructure projects.
Preference shares sit between debt and equity. Like a bond, they pay a fixed return. Like a share, they form part of the company's capital, and the dividend is paid only out of profits. The word preference refers to the order of payment. Preference holders get their dividend before equity holders get anything. In a wind-up they are repaid before equity holders, though after lenders. In return they normally give up the vote and the upside. If profits triple, the preference dividend stays the same.
Cumulative and non-cumulative
What happens when a company skips a dividend in a bad year? That decides this split. On cumulative shares, the missed dividend piles up as arrears. It must be paid in full before equity holders get any dividend. On non-cumulative shares, a skipped dividend is gone for good. Nearly all preference shares issued in India are cumulative. Investors will not accept the other kind without a much higher rate.
Participating and non-participating
Non-participating shares get their fixed dividend and nothing more. Participating shares get the fixed dividend plus a further share of profits. They may also get a share of surplus assets on winding up, after equity holders receive a set amount. Participating shares are rare. They show up mostly in venture capital deals, not in listed companies.
Convertible and non-convertible
Convertible preference shares can be swapped for equity shares at a set ratio. The swap happens at the holder's option or on a fixed date. Compulsorily convertible preference shares, or CCPS, must convert. They are the standard instrument in Indian startup funding rounds. Investors get the safety of a preference share until the company proves itself, then the upside of equity. Non-convertible shares stay as they are until redeemed.
Redeemable and irredeemable
Redeemable shares are bought back by the company at a fixed date or at its option. The holder gets the face value back. Irredeemable shares have no such date. Section 55 of the Companies Act 2013 bars Indian companies from issuing them. Every issue must be redeemable within 20 years. Infrastructure companies get up to 30 years. Redemption must be funded from profits or from a fresh issue of shares, not from borrowed money.
Voting rights
Preference shares usually do not vote on ordinary company matters. They do vote on resolutions that touch their own rights, such as a change to the dividend or redemption terms. There is one more rule in Indian law. If a company has not paid the preference dividend for two years or more, the holders can vote on every resolution, just like equity holders, until the arrears are cleared.
A worked example
A company issues 8% cumulative redeemable preference shares. Face value is Rs 100 and they are redeemable after seven years. An investor holds 1,000 shares. They receive Rs 8,000 a year in dividends, as long as the company has profits to pay from. Suppose the company skips the dividend in year three. The Rs 8,000 goes into arrears and is paid in year four along with that year's dividend. At the end of year seven the investor gets Rs 1,00,000 back. Over those seven years the equity holders may have earned far more or far less. The preference holder earned 8% and had first claim on it.
Why they matter to an investor
Few retail investors buy preference shares directly. Most issues go to institutions by private placement. They matter in three places. On a balance sheet, preference capital is part of share capital but behaves like debt, which affects leverage ratios. In startup valuations, the liquidation preference on CCPS explains why founders and late investors can get very different outcomes from the same exit. And a handful of preference shares are listed on the exchanges. Their yield can suit an income investor who accepts that the dividend is not guaranteed. The comparison with ordinary shares is in equity shares vs preference shares.
FAQs
Are preference dividends taxed?
Yes, at the holder's slab rate, like equity dividends. TDS applies above Rs 10,000 a year from one company.
Can a listed company issue preference shares?
Yes, with shareholder approval and under SEBI rules. Most listed companies have none outstanding.
Which is safer, a bond or a preference share?
A bond. Bond interest is a legal obligation. A preference dividend depends on profits and can be skipped.
What is a CCPS?
A compulsorily convertible preference share. It must convert into equity by a set date. It is the standard instrument in Indian startup funding.