What is Preference Share Capital?

S7-SA7-0058

Grade Level:

Class 12

AI/ML, Physics, Biotechnology, FinTech, EVs, Space Technology, Climate Science, Blockchain, Medicine, Engineering, Law, Economics

Definition

What is it?

Preference share capital is a type of share capital where shareholders have a 'preference' over equity shareholders, especially when it comes to receiving dividends and getting their money back if the company closes down. This means they get a fixed dividend payment before equity shareholders receive anything.

Simple Example

Quick Example

Imagine a company is like a cricket team. Equity shareholders are like the main batsmen who get big rewards if the team wins, but also take more risk. Preference shareholders are like reliable fielders who get a fixed bonus for playing, no matter if the team wins big or just average, and they get their bonus first.

Worked Example

Step-by-Step

Let's say a company, 'Bharat Tech Ltd.', has 1,000 Preference Shares of Rs. 100 each, with a 10% dividend rate, and 5,000 Equity Shares of Rs. 100 each. The company earns a profit of Rs. 70,000 for the year.

Step 1: Calculate the total preference share capital.
Preference Share Capital = Number of Preference Shares * Face Value per share
Preference Share Capital = 1,000 shares * Rs. 100/share = Rs. 1,00,000

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Step 2: Calculate the total dividend payable to preference shareholders.
Preference Dividend = Preference Share Capital * Dividend Rate
Preference Dividend = Rs. 1,00,000 * 10% = Rs. 10,000

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Step 3: Distribute the profit. First, pay the preference shareholders.
Profit available after Preference Dividend = Total Profit - Preference Dividend
Profit available = Rs. 70,000 - Rs. 10,000 = Rs. 60,000

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Step 4: The remaining profit (Rs. 60,000) can then be distributed to equity shareholders or kept by the company.

Answer: Bharat Tech Ltd. will pay Rs. 10,000 as dividend to its preference shareholders first.

Why It Matters

Understanding preference shares is crucial for anyone interested in FinTech or Economics, as it's a basic building block of how companies raise money. Future financial analysts, investment bankers, and even entrepreneurs creating their own startups will use this knowledge to make smart decisions about funding and investment.

Common Mistakes

MISTAKE: Thinking preference shareholders get a higher dividend than equity shareholders no matter what. | CORRECTION: Preference shareholders get a FIXED dividend rate, while equity shareholders' dividends can be much higher (or lower) depending on company profit. They just get paid first.

MISTAKE: Believing preference shareholders have voting rights like equity shareholders. | CORRECTION: Generally, preference shareholders do NOT have voting rights in the company's decisions, unlike equity shareholders who vote on important matters.

MISTAKE: Confusing preference shares with debt (like a bank loan). | CORRECTION: Preference shares are part of a company's capital (ownership), not a loan. While they have a fixed return like debt, they are considered equity and don't have a maturity date like a loan.

Practice Questions

Try It Yourself

QUESTION: A company has 500 Preference Shares of Rs. 100 each, with an 8% dividend. How much dividend will be paid to preference shareholders in a year? | ANSWER: Rs. 4,000

QUESTION: If a company makes a profit of Rs. 25,000 and has to pay Rs. 5,000 to preference shareholders, how much profit is left for equity shareholders? | ANSWER: Rs. 20,000

QUESTION: 'Tech Innovations Ltd.' issues 2,000, 9% Preference Shares of Rs. 50 each. If the company makes a profit of Rs. 80,000, calculate the total preference dividend and the remaining profit for equity shareholders. | ANSWER: Total Preference Dividend = Rs. 9,000; Remaining Profit for Equity Shareholders = Rs. 71,000

MCQ

Quick Quiz

Which of the following is a key characteristic of Preference Share Capital?

They have unlimited voting rights in all company decisions.

They receive a fixed dividend before equity shareholders.

Their dividend payment always increases with company profit.

They are guaranteed to get their money back even if the company makes no profit.

The Correct Answer Is:

Preference shareholders receive a fixed dividend at a pre-determined rate before any dividends are paid to equity shareholders. They generally do not have voting rights, and their dividend is fixed, not necessarily increasing with profit.

Real World Connection

In the Real World

Many large Indian companies, from Tata Motors to Reliance Industries, issue preference shares to raise capital without diluting the control of existing equity shareholders. For example, a startup in the EV sector might issue preference shares to an investor who wants a steady return without taking on the full risk or management duties of an equity partner.

Key Vocabulary

Key Terms

DIVIDEND: A portion of company profits paid to shareholders. | EQUITY SHAREHOLDERS: Owners of a company who have voting rights and variable returns. | FIXED RETURN: A pre-determined income or profit rate that does not change. | LIQUIDATION: The process of closing down a company and selling its assets to pay off debts and distribute remaining funds.

What's Next

What to Learn Next

Next, you should learn about 'Equity Share Capital' to understand the other main type of company ownership. This will help you compare both types of shares and see how companies balance different funding needs.