Preference Shares: Features, Advantages and Disadvantage

What is Preference Shares ?

The method of mass distribution of new shares to a certain set of persons, venture capitalists (VC), company, or any other person by any particular company for fund raising is referred to as preferential issue of shares.

According to Section 81 of the Companies Act of 1956, this is neither a rights issue nor a public offering. When a company distributes shares, it stipulates that preference share holders will be paid first.

Preferential allotment accounts for the majority of the main market. According to the Company Act 2013, Companies in India can raise funds through many means, including Preferential issue, Right Issue, IPOs, ESOPs, and Sweat Equity Shares. The preferential issue is regarded as the finest fundraising option for Private Limited Companies among the prescribed options.

When a firm wishes to raise cash, it can do so by issuing additional shares to the public or through mass assignment of shares to VC or private equity funds, which is known as private placement of shares. The primary reason for preferential share issuance is to assist shareholders who are unable to purchase substantial blocks of stock on the open market due to cost or feasibility. However, these shareholders have no voting rights and are only compensated when the company makes a profit.

Features and Benefits of Preference Shares

The features and benefits of preference shares for investors include:

• Dividends are paid first to the Preference Share Holder
• Preference Share Holder have higher claim on company assets
• There are additional investor benefits available to Preference Share Holder
• Preference Share Holder have Right to Repurchase Shares

Advantages of Preference Shares

• Preference shareholders' capital is always secure. If the company fails or goes bankrupt, preference shareholders will be paid first.
• There are no trading fees, and preferential shareholders get paid first when the company makes a profit, followed by regular share holders.
• If a corporation does not pay a dividend this year, shareholders have the right to receive it in the following years.
• The advantage of raising funds through a preferential issue is that it reduces the costs and time associated in a public issue.
• More importantly, if the firm in question is not performing well at the time yet requires financing, retail investors may be reluctant to engage in the issuance.

Disadvantages of Preference Shares

Along with the benefits described above, there are some drawbacks.

• There are no voting privileges granted here.
• When a corporation declares bankruptcy, preferential shareholders are paid first, followed by NCD (Non Convertible Debentures).
• It is more dangerous than bonds.
• The issuing corporation pays a higher cost than debt.

There are several forms of preferential issues and procedures for preferential share issuance, as well as SEBI rules and regulations. We advise and propose how to generate funds through a preferential issue, as well as where and how to invest in a preferential issue.

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