What Are Preference Shares?
Preference shares are one of the more unique forms of equity. Preferred stock is part of share capital that can have any combination of characteristics not commonly possessed by common stock such as rights to acquire properties, both an equity and an indebtedness instrument, and is typically viewed as a non-equity option. Preference stock has its own set of risks and rewards that are different from other types of common stock. Because preference stock carries less financial risk than common stock, it has been historically less expensive compared to other forms of equity.
The most significant benefit of preferred stock is the ability to leverage, or flip, the share quickly. All but one-third of the companies in the Fortune 500 list do some or all of their business through preference shares. These businesses either use preference shares as part of the transaction for buying a company or as an alternative to borrowing money, sometimes with the assistance of bankers, to fund an acquisition. In either event, the companies with preference shares receive priority in line when there is a liquidity issue on the business's shares.
Another major advantage of preferred stock is the company's ability to increase cash flow. The income from the dividends of preferred stocks is exempt from federal and state taxes, although capital gains taxes can apply to the gain. This allows companies that generate their income from preferred stock to ride out rough patches in the market without having to invest additional capital. Also, companies with preferred stock tend to have higher net worth, a factor that tends to attract investors with more risk.
Preference shares are issued in either call or put options, allowing the holder the option to trade the stock for short or long terms. The price of the preferred stock can vary depending on the direction it takes in the market. When trading preferred stock in the stock market, it is important to understand the potential return and how it will be affected by the overall performance of the market. Dividends are paid quarterly and may not be guaranteed.
If a business chooses to list its preference shares in the stock market, the company must comply with the listing requirements of the Securities Exchange Commission. These requirements can vary from one brokerage to the next. Different brokerage firms also charge different fees for listing preference shares. It is recommended that preference shares are offered to accredited investors.
Businesses may prefer one or more types of Preferred Stock. They often use one or two of these preference routes to finance acquisition projects. It should be kept in mind that if the business becomes unprofitable, the Preferred Stock holders are liable for the payment of the debt. For this reason, Preferred Stocks should be used as financial instruments only. They should never be used to finance acquisitions unless there is an excellent chance of the business becoming successful.
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