Preference share
Also written Preference shares
A share carrying a pre-defined rate of dividend, paid before any equity dividend, with priority over equity in return of capital on winding up — but normally no voting rights.
In plain language
A preference share sits between a bond and an ordinary share. Like a bond, it promises a fixed rate — here a dividend rather than interest. Like a share, the holder is an owner, not a lender, and the dividend comes out of profits only if there are profits to pay it.
The "preference" is about the queue. Preference shareholders are paid their dividend before equity shareholders get any, and are repaid capital before equity shareholders if the company is wound up.
How it works
How it differs from a debenture (section 2.3.2):
| Preference share | Debenture | |
|---|---|---|
| Holder is | A shareholder | A creditor |
| Security | Not secured — it is not a borrowing | Usually secured on the company's assets |
| Payment | Dividend from residual profits after all external liabilities, including tax | Coupon interest is an expense before tax |
How it differs from equity: a pre-defined dividend rate; no voting rights; preference in dividend and in return of capital on winding up; usually not listed, with little scope for capital appreciation, because it does not participate in the company's profits beyond its fixed rate.
Cumulative preference shares. If profits are insufficient, the unpaid dividend can be carried forward and paid in later years when profits allow — if the terms of issue say so.
In a liquidation (section 2.3.1), proceeds go first to claimants such as government, lenders and employees; preference shareholders are paid before equity shareholders, who take whatever is left.
A worked example
Illustrative figures. A company issues 5 lakh 10 per cent cumulative preference shares of Rs 100 each — Rs 50 crore.
Annual preference dividend = Rs 50 crore × 10% = Rs 5 crore
Year 1: a bad year — profits are not sufficient and no preference dividend is paid. Because the shares are cumulative, Rs 5 crore is carried forward.
Year 2: profits recover. Before a single rupee of equity dividend:
Arrears from Year 1 Rs 5 crore
Current Year 2 Rs 5 crore
Total to preference Rs 10 crore
Cost to the company, compared with a 10 per cent debenture, at an illustrative 25 per cent tax rate:
Debenture: Rs 5 crore interest is a pre-tax expense → after-tax cost Rs 3.75 crore (7.5%)
Preference: Rs 5 crore dividend is paid from post-tax profit → cost Rs 5 crore (10%)
That difference is the workbook's point about where each payment sits in the profit and loss account.
Why NISM asks about it
Chapter 2 (Securities: Types, Features and Concepts of Asset Allocation and Investing), section 2.3.2 on types of equity capital, and section 2.3.1 on residual claim. Chapter 3 lists preference shares among the securities private companies and banks issue, the latter as Tier-2 capital. Questions compare preference shares with debentures and with ordinary equity.
Common exam traps
- The workbook says two things that pull against each other — know both. It calls preference shares "a special kind of equity shares", and in the next paragraph says "unlike common equity" they carry no voting rights. It also says they carry no "right over the assets of the company", and immediately after, that they have preference in the return of capital if the company is wound up. Read it as: no security over specific assets and no ownership vote, but ahead of equity in the liquidation queue.
- Preference dividend is paid after tax; debenture interest before tax.
- Cumulative means unpaid dividends carry forward — only if the terms of issue allow.
- Not secured. A preference share is not a borrowing.
- Voting rights. The workbook states the general rule that preference shares carry no voting rights. The Companies Act, 2013 gives preference shareholders a vote on resolutions directly affecting their rights, and on all resolutions where their dividend has remained unpaid for two years or more; answer workbook questions with the general rule.
Where this is taught
- Series II-A · Chapter 1: Introduction to Securitiesintroduced here
- Series X-B · Chapter 11: Taxation of Equity Productsintroduced here
- Series X-A · Chapter 7: Introduction to Investmentsintroduced here
- Series XII · Chapter 2: Securities: Types, Features and Concepts of Asset Allocation and Investingintroduced here
Related terms
- Differential Voting RightsEquity shares that carry less than one vote each, letting a company raise capital without diluting control — and letting an investor who does not want the vote buy the same economics at a discount.
- Convertible debenturesDebentures that turn into equity shares on terms fixed at issue — the investor draws a coupon until conversion, and the company settles the debt in shares instead of cash.
- Equity sharesOwnership in a company entitling holders to a share in profits and a vote on its affairs; equity holders are residual owners after all contractual claims, rewarded by dividend and capital appreciation.
- Cumulative preference shareA preference share whose unpaid dividend is not lost: it is carried forward to later years and paid when there are profits, if the terms of issue allow.
- Residual claimThe equity shareholder's place at the back of the queue: entitled only to profits and assets left after government, lenders, employees and preference shareholders have been paid.
- Conversion RatioThe number of equity shares received for each convertible security, or the share-exchange rate fixed in a merger. It is fairly priced when the shares receivable are worth exactly what is given up.
- Participating preference shareA preference share that pays the holder a specified fixed dividend plus an additional dividend on pre-specified conditions — unlike a non-participating preference share, which gets only the fixed rate.
- Early-stage capitalThe third round of a young company's life — money to set up initial operations and basic production once it has customers, raised in Pre-Series A, Series A or Series B.
- Down roundA financing round priced below the valuation of the previous round — the event that triggers anti-dilution protection and re-prices every earlier investor's conversion.
- Weighted average anti-dilutionThe gentler of the two anti-dilution methods: the conversion price is reset to the average price of all capital raised to date, not to the lowest price the company has ever issued at.
- Non-participating liquidation preferenceA liquidation preference where the investor takes either the guaranteed multiple of its investment or its pro-rata share of the proceeds on conversion — whichever is larger, but never both.
- Securities under the SCRAThe statutory list in Section 2(h) of the SCRA, 1956 that decides what counts as a "security" in India — shares and debentures, but also derivatives, mutual fund units and zero coupon zero principal instruments.
- Liquidation PreferenceA right that, if the investee company is liquidated, the AIF's preferred securities are paid a set amount — its investment or a multiple of it — before other shareholders receive anything.
- Unlisted equity sharesShares not listed on any recognised stock exchange in India: the long-term holding period is 24 months rather than 12, long-term gains are taxed at 12.50%, and short-term gains at normal rates.