Preference Shareholders are those shareholders who have a preference over the equity shareholders. The preference shareholders have a preference over equity in two ways.
One is the preference in terms of dividend distribution out of profits of a company. The dividend is given to them before declaring a dividend for equity shareholders.
The second preference is in terms of receiving capital at the time of liquidation after the settlement of creditors of the company.
There are various advantages of preference shareholder. They are:
- The culminating preference shareholders get a regular share of profits even when there are no profits for the company.
- The rate of dividend on preference shares is generally higher than the rate of interest on debentures.
- The preference shareholders possess preference rights of repayment of their capital as a result of which there are fewer capital losses.
There are some disadvantages also related to preference shareholder. They are:
- The preference shareholders have no voting rights behalf of the company except in matters directly affecting their own interests.
- There is fixed income generated for preference shareholder. In cases where the company generates surplus profits, they are not shared with preference shareholders.
- The company provides no guarantee on the assets of the preference shareholder.
PREFERENCE SHAREHOLDER VIS-À-VIS EQUITY SHAREHOLDER
| BASIS | PREFERENCE SHAREHOLDER | EQUITY SHAREHOLDER |
| The rate of dividend | Their rate of dividend is fixed. | Their rate of dividend is fluctuating. |
| Payment of Dividend | Shareholder has a right to receive dividend before the dividend is paid to equity shareholder | Dividend to the shareholder is paid after the dividend is paid to preference shareholders. |
| Winding Up | On winding up, preference shareholders have right to return of capital. | Equity shareholders are paid only when preference share capital is paid fully. |
| Management | Shareholders are not entitled to participating in the management of the company. | Shareholders are entitled to participate in the management of the company. |
| Voting Rights | They do not have any voting right. | They have a voting right. |
| Capital Payment | Preference shareholder have preferential right to receive capital in event of winding up before anything is returned to equity shareholders | Equity share capital is paid only after full payment is made to preference shareholders. |
| Trading or equity | Preference share help owner derive the benefits of trading or equity | Equity shareholder has availability of only equity share capital in total capital of the company. |
| Company formation | Company which only have preference shareholders cannot be formed | Company may be formed with only equity shareholders. |
PREFERENCE SHAREHOLDER VIS-À-VIS CREDITOR
The company has two ways of raising capital to raise money. One is by the issue of shares and one by debt. Debt capital is that money which company raises through loans. The persons who loan the money are considered as the creditors of the company.
The creditors of company loan their money with the agreement that they would be paid interest on the amount given as a loan at regular periods. This interest amount has to be paid to them irrespective of whether or not the company makes profits.
Also, when the company is winding up, it is under an obligation to repay its creditors’ funds.
Preference shareholder get dividends every quarter that the business makes profits. Creditors receive interests after every irrespective of the fact that the company makes profits or not.
The dividend rate given to preference shareholder and interest rates to creditors are predetermined. These rates are set at the time of procurement of funds by the company.
The creditors have a legal claim on the assets of the company at the time of non-payment of dues. The preference shareholders also get preferential treatment over and above the common stockholders for payments.
Debt capital does not represent ownership in the company. Though creditors have given large sums of money to a company as loans they have no stake in the company. Preference shareholder, on the other hand, have a role in some of the decisions of management of the company.
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