Preference Shares are a separate class of share and have features which can be used to meet requirements of both issuers and investors. Startups in particular often issue Preference Shares as an incentive to attract investment.
What are Preference Shares?
Preference Shares are a separate class of share which incorporate unique features which can be used as an incentive to invest, or to reduce investor risk. There are many variations of Preference Shares, although they share several common features;
Fixed Maturity date
Preference shares have a fixed maturity date. There are several alternatives which can take place at maturity – these are discussed below.
Preference Shares receive dividends before Ordinary Shares ie dividends on Preference Shares must be paid first in full before dividends are paid on Ordinary shares.
In the event that a company goes into liquidation, this class of shares are paid out before Ordinary shares.
Preference shares also carry a liquidation preference which is generally set at “1 times (1x)”. This means the shares are entitled to 1 times their purchase price in the event of a liquidation.
Liquidation preferences can also be greater than 1, and may be 2 or 3 times for example, again as an incentive to attract investors.
Types of Preference Shares
Dividends may be paid as a fixed percentage rate, for example 10% pa, or floating, for example BBSW + 2%.
Convertible means the Preference shares “convert” to either Ordinary shares, or into Cash when predefined criteria are met – upon maturity or sometimes at the discretion of the Company. The rate of conversion into Ordinary shares or cash will be according to a pre-defined formula or $ figure.
Converting means that the Preference shares must convert into Ordinary shares at some point in time or when a known condition occurs. The rate of conversion into Ordinary shares or Cash will be according to a pre-defined formula or $ figure.
Cumulative / Non-Cumulative
If Preference shares are Cumulative, in the event that the Company is unable to pay a dividend, the dividend payment is accrued and accumulates until repaid.
If the shares are Non-Cumulative, the missed dividend payment is not accrued or accumulated.
It should be noted that Ordinary share dividends are not paid until all accrued Preference Share dividends have been paid.
Redeemable / Non-Redeemable
- Redeemable means the shares can be redeemed for cash. The redemption can be triggered by a number of events including;
- at the discretion of the shareholder
- at the discretion of the Company
- at a pre-defined point in time
- a pre-defined event occurring
Participating / Non-Participating
Participating means that, in the event of liquidation, the shares are entitled to receive a share of any surplus assets or profits.
Why Preference Shares?
This class of shares can provide additional incentives to investors by offering a known return or by reducing risk (as they rank above Ordinary shares in the event of liquidation). They are often used by startups when trying to attract investment from professional investors such as VCs or family offices.
Preference shares can be structured to cater for a variety of situations and can particularly be helpful in relation to fundraising. If you need help reach out to the seasoned team at Fullstack whom can help with startup accounting advice.