Generally, holders of preference shares have an advantage over ordinary shareholders when it comes to dividend payments. They also have an advantage if the firm ceases operations or goes into liquidation.
Preference shares come in several forms, with various rights and features. Preference shareholders often only have the ability to vote on specific issues or resolutions, though this will vary depending on the terms of the shares.
Some of the pros of investing in these types of shares include:
Priority in dividends, with entitlement to a fixed dividend before any dividends are paid to ordinary shareholders
A greater claim against company assets in the case of bankruptcy and subsequent liquidation (which is why preference shares naturally draw cautious investors who appreciate the security of the built-in downside risk protection)
The option for investors to exchange these kinds of preference shares for a certain number of ordinary shares through a subcategory of preference shares known as convertible shares. These can be profitable if the price of ordinary shares starts to rise. Such participating shares allow holders to receive additional dividends beyond the specified rate if the company achieves specific pre-established profit goals.
Cons of preference shares include:
Limited potential for capital appreciation (as the dividends on preference shares are fixed, which means that their value is not directly tied to the company’s performance, therefore restricting their potential for capital appreciation)
No voting rights, meaning preference shareholders do not have a say in the company’s management or direction (which can be a disadvantage for those who want to have a more active role in the company’s operations)
Dividend payments are not guaranteed (as whilst preference shareholders are entitled to these, these payments are not guaranteed and can be suspended or eliminated at the discretion of the company’s board of directors)