De-Jargoned | Preferential shares

De-Jargoned | Preferential shares

What are these?

These are stocks of a company through which you get more right over the company’s profits and assets as compared with common stocks. These are typically issued for a fixed number of years at the end of which they are bought back by the company.

Types of preferential allotment

Based on the dividend payment mode, preferential shares are of two types—cumulative and non-cumulative. Under the cumulative preferential arrangement, annual dividend is inherent. The rate of dividend is specified in the share itself. For example, 8% preference shares signify a dividend rate of 8%. If in a given year, dividend is not paid to an investor, it is added in the next year’s payment. In a non-cumulative preferential arrangement, the dividend payment lapses if the company is unable to pay for a particular year.

What are the benefits?

First, preferential shares usually have a fixed rate of dividend for a fixed number of years. So the dividend amount does not fluctuate along with the market over the said number of years.

Second, preferential shares are a lot safer when compared with normal stocks of a company. If the company goes bankrupt, preferential shareholders will get the money first after the sale of assets and only then will normal shareholders be considered.

What are the drawbacks?

The main drawback of this type of share is that it is not traded in the market like ordinary shares, which means that the price discovery is limited. Also, they are not available to retail investors as preferential issues are usually privately placed with institutional or ultra high networth individual buyers.

Who can buy preferential shareS?

Since preferential shares are not traded on the stock exchanges, they are not available for retail investors. Usually, companies issue these shares to financial institutions and other lending firms. A company rarely invites retail investors to buy its preferential shares.

However, if you are interested in buying preferential shares of a company, you can do so through your broker. Companies also reach investors and lending institutions through brokerage firms.

How to sell these shares?

If you want to exit these shares before the company buys them back, you will have to do a private placement via a broker at a negotiated price. The price you receive will depend on the financial state of the company, the prevailing market environment and the premium the buyer is willing to pay for the assured dividend. You may even have to sell at a discount as it will mostly be a negotiated price and not a market price.