Preference shares

What it means

Preference shares carry a priority right to dividends or to a share of the liquidation surplus. In exchange for this advantage, voting rights are usually limited or excluded altogether. They suit investors who want a return but have no interest in running the company.

Unlike ordinary shares, which carry the usual bundle of rights including voting, preference shares give the holder an economic advantage. The preferential dividend is paid before ordinary shareholders receive theirs and may be set as a fixed amount, a percentage or cumulatively for years in which it was not paid.

The Commercial Code allows preference shares in a joint-stock company and limits their share of registered capital if they carry no votes. Voting rights may revive, however, if the company fails to pay the preferential dividend. The simple joint-stock company offers even more freedom in share classes.

How it works in practice

Preference shares are used when a financial investor comes in wanting a priority return and protection on a sale or liquidation, while the founders keep control. They are often combined with a liquidation preference guaranteeing that the investor gets its money back before others.

In family businesses they can help with succession: family members not involved in management receive shares with a preferential dividend, while those running the business hold voting ordinary shares. Income is thus separated from decision-making.

The rights attached must be described precisely in the articles: the amount and calculation of the preferential dividend, conditions for reviving voting rights, ranking in liquidation and any conversion into ordinary shares. Vague articles lead to disputes between classes of shareholders.

What to watch out for

A preferential dividend can be paid only out of profit available for distribution. If there is no profit, the preference shareholder receives nothing unless the articles grant a cumulative right, and even then it is not a company debt the way a loan is.

For tax purposes, dividends on preference shares are generally treated like those on ordinary shares. If the return is guaranteed and independent of profit, however, the tax authority may examine whether it is really interest on financing, with different tax consequences.