What Are Redeemable Preference Shares?

Companies issue equity capital to procure money to finance their operations. Equity capital is raised by issuing common shares (also known as "equity shares") or preference shares. Equity shares provide the shareholder voting rights in the company, and preference shares assure the shareholder of a fixed dividend rate whenever the company chooses to declare dividends.

There are several classifications of these two basic forms of shares. Redeemable preference shares are a special type of preference shares which are very popular.

The company issues redeemable preference shares for a specific time period. These shares are issued when the company has some growth and expansion plans in mind. The company raises the equity capital money today; it does not take on the additional responsibility of debt.

The shareholders can choose the time to maturity on these shares. At the end of the stipulated period, they can choose to exchange these shares for either equity shares of the company or for cash. The shareholders are repaid the face value of the shares plus the dividends.

These shares are always given preferential treatment over other classes of shares. They get priority in payments over common stockholders. These payments pertain to both quarterly dividend payments, as well as the payments that are made when the company is eventually liquidated. Then the assets are used first to pay the creditors of the company and if money still remains, the redeemable preference shareholders are paid. A majority of the time, redeemable preference shares are favoured over other classes of preference shares as well.

Though these shareholders get priority in payments, they have no voting rights in the company. Redeemable preference shares are often viewed as a hybrid form between equity and debt. These shares are issued for a stipulated time frame just like debt. The holders of these shares are paid dividends in place of interest. The shareholders neither have any claim on the assets of the company, nor any say in the conduct of the business.

The prices of both equity and preference shares keep fluctuating. The main reason is the change in the profitability situation of the company. Redeemable preference shares come with a set dividend rate. Equity shareholders get to share all the company's profits that remain after the creditors and preference shareholders have been paid. The redeemable preference shareholder must carefully evaluate the price variations before he decides on redeeming his preference share for an equity one.