Preference and Ordinary Shares

While both preferred shares and common shares give shareholders ownership in a company, they come with different shareholder rights. Preference shares, also known as preferred shares, have the advantage of a higher priority claim to the assets of a corporation in case of insolvency and receive a fixed dividend distribution. These shares often do not have voting rights and can be converted into common shares. 

One way to think of preference shares is as a hybrid of a bond and a security. For this reason, preference shares are often used by venture capitalists for startup companies.

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Preference Shares

Dividends

Dividends for preference shares are set at a specific rate. However, owning preference shares does not guarantee dividend payment. Preference shares can be cumulative or noncumulative. For cumulative shares, if a corporation fails to pay a dividend, that dividend amount is owed at some point in the future. The shares accumulate outstanding dividends.

For noncumulative shares, a dividend is lost if it is not paid. The dividends are paid to preference shareholders prior to common owners receiving dividends. Dividends from preference shares (also called qualified dividends) may be given favorable tax treatment, as opposed to dividends paid to common owners (also called ordinary dividends).

Another type of preference shares is participatory shares. These shares include not only a guaranteed dividend payment but also payment of an additional dividend amount if the corporation meets certain performance goals.

Bankruptcy

In the event of bankruptcy or liquidation, preference shares are paid according to their par value only after payments are made to outstanding bondholders. Preference shareholders receive payment prior to common shareholders receiving anything. Still, there is a risk in being behind creditors. Due to this risk, investors may want to focus on preference shares in companies with strong credit ratings where there is a lower likelihood of default.

In contrast, ordinary shares, also known as common shares, have a lower priority for company assets and only receive dividends at the discretion of the corporation’s management. They are generally entitled to one vote per share.

Article Sources
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  1. Code of Federal Regulations. "§ 1.305–5 Distributions on Preferred Stock," Pages 33-34. Accessed Aug. 17, 2021.

  2. Internal Revenue Service. "Topic No. 404 - Dividends." Accessed Aug. 17, 2021.

  3. United States Code. "11 U.S.C. 507, Pages 109-111. Accessed Aug. 17, 2021.

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