Preferred stock is a special class of ownership in an organization or company that aims at providing a higher claim on earnings and assets as compared to common stock. There is hardly any tax advantage to the issuing of preferred shares when compared to the other forms of finance such as shares or debt.
Still, there are many other reasons why a company chooses preferred shares, all of which totally relate to the financial advantages that it provides. There are several benefits to a company issuing preferred shares such as ease of raising capital, no voting rights to shareholders, and no additional debt load.
Let’s discuss some of the advantages of preference shares in detail. So let’s dig deep into its advantages:
- Dividends Paid First:
The chief benefit for shareholders in preference shares is that preference shares have a fixed dividend that must be paid before any common shareholders.
Dividends are paid only when the company is in profit but some types of preference shares are called cumulative shares allow for the accumulation of unpaid dividends. Once the company turns back to profit, all the unpaid dividends must be paid before any dividends can be paid to common shareholders.
- Higher Claim on Company assets:
In addition, if any event of bankruptcy or liquidation happens then preferred shareholders must have a higher claim on the company’s assets than common shareholders do.
This makes preference shares alluring to investors with low-risk tolerance. The company guarantees a dividend every year to the holders, but if it fails in making a profit, preference shareholders are compensated for their investments.
- Lack of Shareholder Voting Rights:
The lack of shareholder voting rights may seem like a drawback to the investors but it can be beneficial to the business because this ownership is not diluted by selling preferences shares the way ordinary shares are issued.
- Additional Investor Benefits:
Preference shares carry many additional benefits. Convertible shares allow the investor to invest in preference shares for a fixed number of additional shares. This can be of a great deal if the value of common shares begins to jump.
- Right to re-purchase shares:
Companies can include callable preference shares, which gives them the right to repurchase shares at their discretion.
This means if the callable shares are issued within 6% dividend but at the same time interest rate falls to 4%, then the company has the right to purchase any outstanding shares same as market price and then re-issue shares with a lower dividend rate, hence reducing the overall cost of capital.