Preference Share Capital is often considered as a hybrid form of financing because it has many features of both equity shares and debenture. It resembles equity capital in the following ways :
(i) the non-payment of dividend does not force the company to insolvency in other words,
(ii) preference dividend is not an obligatory payment;
(iii) dividends are not a tax-deductible payment,
(iv) in some cases, preference shares have no fixed maturity date.
On the other hand, it is similar to debentures is that
(i) dividend rate of preference shares is usually fixed just like it is fixed on debentures,
(ii) preference shares don’t share in residual earnings,
(iii) preference shareholders normally don’t enjoy the voting right.
Features of Preference Shares
Reference shares have the following features :
(i) Claim on Income and Assets. Preference shares have a prior claim on the company’s income/dividends during its life time and prior claim on the assets of the company in the event of liquidation. Preference capital is paid after that of a debenture and before that of equity shares.
(ii) Voting Rights. Preference shareholders have no voting right but they are granted voting right if the company skips preference dividend for three years.
(iii) Fixed Dividend. The dividend rate paid to the preference shareholders is fixed and dividends are not tax deductible also. There is no legal obligation to pay preference dividend. A company doesn’t have to face bankruptcy or legal action if it skips preference dividend except granting the voting right as explained above.
If the preference shares are cumulative, it protects the preference shareholders. Cumulative dividends feature added with preference shares means that all past unpaid preference dividend will be paid before any ordinary dividends are paid.
(iv) Redemption. Redeemable preference shares are those which have a specified maturity date whereas irredeemable preference shares are permanent or perpetual which are payable only in the event of winding up of a company.
(v) Call Feature. The call feature permits the company to buy back preference shares at a stipulated buy-back price or cell price. Call price may be higher than the par value or lower than the par value. The difference between call price and par value of the preference share is called call premium.
(vi) Tax-Exempt. Preference shares are tax-exempt in the hands of investors. The paying company, however, is required to pay & dividend tax of 10 percent.