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- Preferred shares are an investment in company ownership and the right to claim dividends from that company’s operations.
- Preferred shareholders have a higher priority for dividend claims than common shareholders.
- Preferred shareholders are unlikely to have voting rights in the same way common shareholders do.
- Preferred stock shares traits with both common shares and bonds, which many investors find appealing.
Preferred shares or preferred stock, are shares which are paid out (in dividends) before ordinary or common shares. Here we explain the pros and cons of preferred shares as part of your company ownership structure, or as an investor.
What Are Preferred Shares?
Businesses use several devices to attract investment, including bonds, common shares, and preferred shares—also known as preferred stock. Each has its own potential rewards and risks, which should be considered carefully before deciding to purchase. In the case of preferred shares (whether full or partial shares), the main attractions are regular, high-priority dividend payouts and low volatility in value.
While the specific rules and conditions attached to any issuing of shares can vary greatly, certain common factors mark preferred shares as different from common shares.
- Preferred shares are issued at par value and maintain that value. The value of a common share is dictated by the markets and can fluctuate greatly.
- Preferred shares usually do not come with voting rights, except in certain circumstances. Common shares often have voting rights attached.
- Preferred shares are priority dividend shares. Holders of preferred shares receive payouts before those of common shares, who may miss out when the available pot is limited (See Investopedia).
- Similarly, in the event the issuing business is liquidated, preferred shareholders are prioritized over common shareholders in the creditors’ queue.
- Finally, preferred shares can be converted into common shares in certain situations. The reverse is not usually the case.
MSA helps you assess whether preferred shares, equity injections, or other capital tools are the most compliant and tax-efficient for your China entity. Message →
What Are the Advantages of Preferred Shares?
Preferred shares come with two main advantages: dividend priority and stability.
When dividends are due, only bonds receive a higher priority than preferred shares. If a company defaults and is at risk of liquidation, preferred shareholders are generally prioritised over common shareholders and may still receive dividend payments, depending on the share class. This likelihood, however, is affected by the type of preferred share that has been issued. There are several types of preferred shares, each coming with its own qualities and, crucially, its own place in the dividend queue.
1. Prior
Preferred shares are paid in order of issue. Prior preferred shares are those issued first and, therefore, the first to receive their dividend.
2. Preference
These are issued with the specific promise of being higher up the rankings for dividend payouts. They often come in tiers of seniority, which also impacts the order of dividends.
3. Perpetual
Most preferred shares are perpetual, meaning they never expire, and the original capital investment can only be returned via a sale. The alternative to perpetual shares is those with a fixed date at which the capital investment is automatically returned.
4. Convertible
Some preferred shares can be converted to common shares at a time of the investor’s choosing. This can be done regardless of the value of either share and cannot be reversed. The number of common shares each preferred share is worth is usually predefined during the original sale.
5. Cumulative / Non-Cumulative
Over the course of a share’s lifespan, it is likely not every dividend payout will be made. If a share is cumulative, then a company must make up for any missed dividends at a later date when the funds are available. For non-cumulative shares, a missed dividend is lost forever. All back payments must be completed for cumulative preferred shareholders before common shareholders receive new dividends.
6. Participating
Some shares come with extra payout promises in addition to standard dividends. So long as the issuing company hits certain targets, usually for sales, earnings, or margins, the holder of these shares will receive a payment. These must be paid, even when dividends are not.
As well as offering enhanced priority for dividend payouts, many investors like preferred shares because they are stable (See Corporate Finance Institute). Their value does not change with the market and they offer a regular income. This makes them ideal for investors who prefer to avoid exposing their portfolios to undue risk.
| Type of Preferred Share | Dividend Priority | Voting Rights | Convertibility | Risk Level | Best For |
|---|---|---|---|---|---|
| Prior Preferred | Highest among preferred classes | None | No | Low | Investors seeking most-secure dividend queue |
| Preference Preferred | Higher than standard preferred | None | No | Low–Medium | Investors wanting structured dividend tiers |
| Perpetual | Standard | None | No | Medium (interest-rate sensitivity) | Long-term income-focused investors |
| Convertible | Standard | None | Yes → Converts to common | Medium | Investors seeking equity upside |
| Cumulative | Very high (missed dividends must be paid later) | None | No | Low–Medium | Risk-averse income investors |
| Participating | Standard + bonus payouts | None | Sometimes | Medium–High | Investors wanting income plus performance upside |
What Are the Risks and Challenges of Preferred Shares?
While preferred shares are among the least volatile investments that can be made, they are not risk-free. The lack of voting rights presents a challenge in that the buyer has little to no say in the running of the company so is unable to influence the fate of their investment.
The second main risk associated with preferred shares comes with interest rates. Due to their set value and dividend payouts, the value of preferred shares decreases when interest rates rise and increases when they fall. While this is usually far more predictable and less volatile than market values, it is still something to bear in mind when investing.
Preferred shares with liquidation preferences and anti-dilution protections appeal to venture investors but can complicate future financing rounds and acquisition negotiations if not carefully structured. China corporate services experts at MSA Asia help structure equity transactions that satisfy investor requirements while maintaining founder control. Get in touch to design your equity structure.
Thanks to their regular dividends and higher priority payouts, preferred shares are similar to bonds in many ways. Key differences include the fact that bond interest is fixed while the dividends of preferred shares can fluctuate. However, unless specified, a preferred share will continue to pay for as long as it is held, while a bond will usually have a fixed maturity date. Finally, bondholders are at the top of the creditors’ queue in the event of bankruptcy or liquidation, though preferred shareholders are not far behind.
The essential thing to remember when investing in preferred shares is that every issue can be different. Always be aware of the details such as the type of share, the rights that come with it, and whether the company selling has the right to recall it when they choose. As preferred share payouts are linked to company performance, it is also important to assess the health and likely prospects of the business before investing.
