John Barnes Non Exec Director explains WHAT ARE PREFERENCE SHARES?
Preference shares are so called because they have ‘preference’ over ordinary shares for payment of dividends and return of capital. However, they are junior to all forms of company debt, including debentures, loan notes and bank debt if the company is wound up.
Preference shares can be thought of as a hybrid between an ordinary share and a corporate bond.
Their key features are:-
- Preference shareholders receive a fixed dividend, usually twice a year, similar to the interest (‘coupon’) paid on a bond;
- Dividends on preference shares are paid out of taxed company profits and thus treated as ‘franked investment income’ so are paid ‘net’, meaning the basic-rate UK income tax has already been deducted, as with dividend income;
- Preference dividends must be paid out before any dividends to ordinary shareholders;
- Most Preference Shares are undated, but one or two have a final redemption date and some have a Call Date which means a date of which the issuer can (but is not obliged to) redeem the shares.
- Some Preference Shares are cumulative which means that the company must pay any dividend arrears from previous years before it can pay an ordinary dividend.
- Purchases of Preference Shares, like ordinary shares, are subject to 0.5% stamp duty. The capital gains and income tax treatment is also the same as for ordinary shares.
- Unlike bond interest, though, failure to pay a preference dividend cannot force the company into administration. However, most preference shares are ‘cumulative’; this means any preference dividends not paid will be accrued until funds are available.
- If the business is wound up and there is any capital left over after paying the various creditors, preference shares are repaid before ordinary shares.
For the investor, preference shares can be seen as less risky than ordinary shares but riskier than bonds. Conversely, for the company, paying preference dividends is more onerous than paying ordinary dividends, but without the imperative of paying interest.