What is Preference Share?
A preference share is a type of share that sits somewhere between equity and debt.
Investors who hold preference shares receive priority in dividend payments. That means the company pays them first, usually at a fixed rate, before distributing anything to equity shareholders. If the company is ever wound up, preference shareholders also rank ahead of equity holders in the repayment of capital.
Because of this structure, preference shares are often seen as a middle ground. They offer more stability than regular equity shares, but they don’t provide the same ownership rights or voting power in most cases.
In India, companies issue preference shares under the provisions of the Companies Act, 2013.
Investors who want to participate in such securities in the stock market typically need a demat and trading account with a registered broker. Today, many platforms allow investors to open free demat account online and start accessing different types of market instruments, including shares issued by companies.
Also Read: What are Shares?
Key Features of Preference Shares
Preference shares aren’t the same as regular equity. They come with a few specific characteristics that investors should be aware of.
If you’re reviewing a company’s capital structure or doing fundamental analysis, it’s worth checking how these shares are structured and what rights are attached to them.
- Preferential Dividend: Shareholders receive dividends at a fixed percentage before any payments are made to others.
- Priority in Repayment: In the event of winding up, they are the first to receive their capital back among all shareholders.
- No Voting Rights: Generally, these shareholders do not have the right to vote on company resolutions, keeping control in the hands of equity holders.
- Hybrid Nature: They provide a fixed rate of return like a debenture, but are technically part of the company’s net worth like equity shares.
- Redemption Period: Unlike ordinary shares, these often have a fixed tenure after which the company must repurchase them.
Also Read: What is Equity Trading?
The Different Types of Preference Shares
Investors can choose from various types of preference shares based on their risk appetite and financial goals.
Cumulative vs. Non-Cumulative
In cumulative shares, if a company fails to pay dividends in a particular year due to losses, the unpaid dividends accumulate and must be paid in the future. In non-cumulative shares, if no dividend is declared for a year, the shareholder loses that income forever.
Participating vs. Non-Participating
Participating shareholders have a right to share in the company’s surplus profits after the fixed dividend is paid. Non-participating shares only entitle the holder to the fixed dividend rate and nothing more.
Convertible vs. Non-Convertible
Convertible shares allow the holder to change their preference shares into ordinary equity shares after a pre-determined period. Non-convertible shares do not have this option and remain preference shares until redemption.
Redeemable and Irredeemable Preference Shares
Some preference shares are issued with a clear exit timeline. These are called redeemable preference shares. The company agrees to return the capital after a defined period, which in India can go up to 20 years in most cases.
Irredeemable preference shares, on the other hand, do not come with a fixed repayment date. However, under current Indian regulations, companies are not permitted to issue irredeemable preference shares.
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Preference Shares vs Equity Shares: How They Really Differ
Although both types of shares represent a stake in the company, they serve very different purposes for investors.
Preference shares generally come with a fixed dividend rate. Equity dividends, in contrast, are not guaranteed and depend entirely on the company’s performance and whether profits are distributed.
Voting rights also differ. Equity shareholders typically have the power to vote on major corporate decisions, including the appointment of directors. Preference shareholders usually do not have regular voting rights, except in specific circumstances.
In terms of risk and return, equity shares tend to be more volatile but offer stronger long-term growth potential. Preference shares are comparatively stable and are often chosen by investors who prefer predictable income over capital appreciation.
If a company faces liquidation, the repayment order becomes important. Creditors are paid first, followed by preference shareholders. Equity shareholders stand last in line.
There’s also the matter of unpaid dividends. Certain types of preference shares allow unpaid dividends to accumulate and be paid later. Equity shares do not carry such a provision.
Also Read: What is Trading Account?
Why Some Investors Consider Preference Shares
Preference shares usually attract investors seeking something more predictable than equity.
The biggest appeal is the dividend structure. Since the dividend rate is generally fixed, the income stream tends to be more stable than that of ordinary shares, where payouts depend entirely on profits and board decisions.
There’s also a layer of priority attached to them. If a company faces financial trouble, preference shareholders are ahead of equity holders in the repayment of capital. That positioning doesn’t eliminate risk, but it does change the order in which claims are settled.
They also usually come without regular voting rights, which means investors receive income priority but don’t actively participate in most company decisions.
Preference shares usually don’t move in the market the way equity shares do. People generally buy them for the dividend income, not for rapid price growth, so trading activity tends to stay relatively steady.
Also Read: What is Demat Account?
Taxation and Regulatory Position in India
In India, companies issue preference shares under the Companies Act, 2013. One important point is that they can’t remain outstanding forever. Companies are required to redeem them within a defined period, which is typically up to 20 years, although certain long-term infrastructure projects may be given more time.
From a taxation standpoint, dividends from preference shares are treated like any other dividend income today. Since the Dividend Distribution Tax was removed, the tax burden shifted to investors. This means that dividend income is added to your total income and taxed at your individual slab rate.
If you exit by selling the shares, or if the company redeems them, capital gains tax applies. The rate depends on how long the shares were held, short-term or long-term.
Also Read: What is DP ID in Demat Account?
Conclusion
Preference shares tend to appeal to investors who value predictability. They don’t offer the same growth potential as equity shares, but they do provide priority in dividend payments and capital repayment.
For someone looking to balance risk within a portfolio, they can serve a specific purpose, especially where steady income matters more than rapid capital appreciation. Whether acquired through a fresh issue or in the secondary market, preference shares are often used as a middle-ground instrument between debt and equity.
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Frequently Asked Questions
Generally, no. Preference shareholders only gain voting rights if their dividends remain unpaid for two years or more, or if a resolution directly affects their rights.
Not exactly. Dividends are paid only if the company makes a profit. However, for cumulative preference shares, any missed dividends must be paid in the future.
Preference shares represent ownership in a company and dividends are paid from profits. Debentures represent debt, and interest must be paid regardless of whether the company makes a profit.
No. Under the Companies Act 2013, companies in India cannot issue irredeemable preference shares. They must be redeemed within a maximum period of 20 years.
In case of bankruptcy, preference shareholders are paid after the company settles its debts with secured and unsecured creditors, but before equity shareholders receive any remaining funds.
No. Dividends from preference shares are taxed in the hands of the investor according to their applicable income tax slab rate.
Yes, but only if they were issued as convertible preference shares. In such cases, they can be converted into equity shares based on the terms specified during issuance.
Issuing preference shares allows companies to raise capital without increasing their balance-sheet debt or affecting their debt-to-equity ratio, while also avoiding dilution of voting control.
Participating preference shares allow investors to receive a fixed dividend and also share in additional profits after equity shareholders receive their dividends.
It depends on your investment goal. Equity shares offer higher growth potential but involve more risk, while preference shares provide relatively stable income with lower risk.