There is no set form of “preference share”, the name merely indicates that the shares have some preferential right in relation to the other shares held in a company. For example, it might be a preferential right to receive dividends, to receive capital back on a winding-up of the company or to enhanced voting rights in certain circumstances. Often preference shares have a number of preferential rights.
Preference shares are often a hybrid between lending money to a company and taking a traditional equity stake. On one hand you can receive a fixed or variable return and oblige the company to pay back your capital on a particular date or in particular circumstances, much like a traditional loan. On the other hand the return on preference shares (in the form of dividends) can only be paid if the company has accumulated a profit. Preference shares will also rank behind secured and unsecured creditors, but usually ahead of other classes of shares in recovering their capital. Preference shareholders may also receive an enhanced return if the relevant company is doing well, much like a traditional equity stake.
Preference shareholders typically wish to be compensated for the additional risk associated with subscribing preference shares over a loan by receiving a higher rate of interest (by way of dividend) or by “participating” in the profits and capital growth of the relevant company.
If a company wants to borrow money but also needs to adhere to banking covenants or otherwise keep its gearing low, it may issue preference shares; which constitute equity rather than debt
Preference share dividends will often be fixed (if there are accumulated profits to pay them) and do not require the shareholders or directors to declare a dividend as would be the case with ordinary shares. They may also be cumulative so that if the company does not make enough profit to pay the entire dividend in one year it gets rolled over to the next. If preference shares are “participating” then they may also be entitled to participate in any additional dividend and distribution of assets that may be paid to other shareholders
Preference shareholders are likely to want an exit route from the company. As a result preference shares are often redeemable on a fixed date. They may also be convertible to ordinary shares in certain circumstances.
If you are thinking of issuing preference shares then you will need to consider any relevant restrictions in the company’s Articles of Association, the revisions that will be necessary to the Articles and whether any pre-emption rights need to be waived or varied in order to accommodate the issue. You will also need to ensure compliance with relevant company law (particularly the Companies Act 2006).
When considering an issue of preference shares one needs to consider the fact that existing ordinary shareholders are likely to have a pre-emption right on the issue of new shares in a company. In most circumstances this means that any new shares issued by a company must first be offered to existing ordinary shareholders pro rata to their current shareholding. Existing shareholders may waive this pre-emption right in a number of ways.
If the shareholders of the relevant company have entered into a Shareholders Agreement, it may dictate whether and to whom preference shares may be issued.
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