Introduction
If you have siblings, you most definitely have heard this question posed or have yourself posed this question to your parents – who is your favourite? The answer most times is a denial of having a favourite and loving all children equally or distraction from the question. Either way, in your heart, you know that one of you does win out. One of you is better liked or preferred by your parents only because they are lesser trouble. Not because they are by any degree nobler or more intelligent. Our parents are adept at displaying love equally to both siblings regardless of how well-deserving they are of the love. But there are instances when a parent might slip up. Handing you the last pizza slice or letting you ride shotgun on a road trip or choosing your favourite movie for movie night. All of these are tiny indications that you are the favourite. If not the favourite, the better preferred. They give you special treatment.
Having special treatment can go a long way. Being given first preference can make you avoid all unwanted things. For example, when having a sleepover, you could pick not to sleep next to that cousin who is known to wet the bed or while planning a wedding dinner, you could choose the spot that is the farthest from your nosy aunt and her picture-perfect daughter or while travelling, you could choose the window seat so you have the option to avoid conversation by looking at the scenic view outside. Having a preference has benefits. The same goes for preference shareholders. In the financial world, there are broadly two types of share capital – equity and preference share capitals. Preference shares or preferred stock is the company stock that receives dividends before they are issued to the equity shareholders i.e. they are given precedence over the equity shareholders.
Redeemable Preference Shares vs Irredeemable Preference Shares
Even preference shares have various types – Cumulative, non-cumulative, participating, redeemable and irredeemable. Of these, let us see how redeemable preference shares differ from irredeemable preference shares. The main difference between them is their money-back policy. With redeemable preference shares, one can buy the money issued to the company within its maturity date, while with irredeemable preference shares, the share cannot be redeemed or repaid as long as the company is active. There are other differences between the two.
Differences Between Redeemable and Irredeemable Preference Shares in Tabular Form
| Parameters of Comparison | Redeemable Preference Shares | Irredeemable Preference Shares |
| Definition | Redeemable preference shares are preference shares that can be bought back by the company as long as it is within the predetermined maturity period. | Irredeemable preference shares are preference shares that cannot be bought back by the company till it is a going concern. |
| Option to buy-back | A company has the option to buy back the redeemable preference shares as long as it is within the maturity period by notifying the shareholders. | Irredeemable shares do not offer the company an option to buy back these shares. |
| Perpetuity | Redeemable preference shares do not exist till perpetuity. They only exist as long as their maturity lasts. | Irredeemable preference shares exist till perpetuity or till the company exists. |
| Extinguishment of shares | Redeemable preference shares can be extinguished at any time as long as it is within the maturity period. | Irredeemable preference shares can be extinguished only at the time of liquidation. |
| Benefits to issuing company | Redeemable preference shares offer the benefit of flexibility to the issuing company. The redeemable shares can be bought back at a predetermined price. This price may be lower than the market value. | Irredeemable preference shares do not offer any benefit to the issuing company. |
| Certainty to shareholders | Redeemable preference shares offer certainty regarding the amount the shareholders would receive at the time of buy-back of the shares. | Irredeemable preference shares do offer certainty regarding the dividend but they do not offer certainty about the return of the share price itself. When the company undergoes liquidation, the shareholders receive a claim on the assets depending on the financial state of the company. |
| Continuity of dividend payments | Dividend payments on redeemable preference shares continues as long as they are not bought back. | Dividend payments on irredeemable preference shares continue for perpetuity. |
| Popularity | Redeemable preference shares are more popular since they offer more flexibility to the company. They are often favoured by venture capitalists as they provide a predetermined exit strategy for investments. | Irredeemable preference shares are not as popular and are rarely used as they do not offer benefits to the issuing company and the shareholders. |
What are Redeemable Preference Shares?
Redeemable preference shares are an effective way to finance a company. They are preference shares that can be bought back by a company so long as they do it within the period of its maturity. Typically, a company reserves the right to repurchase its shares for its reasons. As a result, redeemable preference shares are repurchased on a predetermined date at a predetermined rate or by announcing the same in advance. This agreed-upon date is also known as the ‘call date’ and therefore, redeemable preference shares are also called ‘callable’ preference stock. Thus, it is a sort of agreement between the company and its shareholders.
The chief purpose for issuing redeemable preference shares is that there is a flexibility to buy back these shares if and when they wish to. This can be seen in the following example.
Company A issues redeemable preference shares with the face value of 100 rupees. These shares have a redemption clause, a maturity period of 20 years and a redemption price of 500 rupees. Suppose, after ten years the company wishes to repurchase a few of the shares. The market price of the shares at this point is 550 rupees. Company A can buy back the redeemable preference shares at 500 rupees compared to the price available in the market.
It has been found that redeemable preference shares are beneficial at the time of inflation to cushion its impact and when there is a decline in the monetary rate. Redeemable preference shares offer the company the benefit of being flexible. When the value of stock declines, the company will have the option of redeeming the shares to refinance them at a lower dividend rate or simply repurchase them (paying the cash to the shareholders).
Advantages of Redeemable Preference Shares
- As already mentioned, with redeemable preference shares, the company has the option to redeem or repurchase the shares.
- It increases earnings per share (EPS). When shares are redeemed, the total number of shares reduces.
- There is increased share value for shareholders. Shares that pay the coupon rate – a rate higher than the present dividend yield – are removed when the preference shares are redeemed. This causes the share value to rise for the current shareholders.
Disadvantages of Redeemable Preference Shares
- Share redemption occurs only at a fixed date determined when the redeemable preference shares are issued.
- Share redemption is only advantageous to the company when the call price is lower than the market price of the shares.
Limitations of Redeemable Preference Shares
- The option to redeem shares is only available when the company offers redeemable preference shares.
- Redeeming shares is not entirely up to the company. They have to wait till it gives them an advantage over the market.
When redeemable preference shares are retired, a special sum as per the contract is paid to the shareholders.
What are Irredeemable Preference Shares?
Irredeemable preference shares are preference shares that can be redeemed only at the time of liquidation of the company. At the time of their issuing, there is no clause about the redemption of the shares and thus, they cannot be bought back. They are not as popular as redeemable shares.
Irredeemable preference shares remain in existence as long as the company is active. They are perpetual and do not have a predetermined maturity date. These shares are only exhausted once the company liquidates. The shareholders then receive a share of assets in exchange for the extinguishment of the irredeemable preference shares.
Irredeemable shares often become a permanent liability to the company i.e. the company becomes obliged to pay the dividends to the shareholders. They offer no benefits to the company or the shareholders and exist in theory. Several jurisdictions have imposed restrictions on the issuing of irredeemable preference shares.
Main Differences Between Redeemable and Irredeemable Preference Shares In Points
Following are the main differences between redeemable and irredeemable preference shares:
- Redeemable preference shares are preference shares that can be bought back by the issuing company as long as it is within the maturity period, while irredeemable preference shares are preference shares that cannot be bought back.
- Redeemable preference shares offer the company a chance to be bought back within the maturity period, but this buy-back option is not offered by irredeemable preference shares.
- Redeemable preference shares do not last till perpetuity. They only last as long as they are bought back. Irredeemable preference shares, on the other hand, last till perpetuity for as long as the company exists.
- Redeemable preference shares can be extinguished at any point as long as it is within the maturity period, whereas irredeemable preference shares cannot be exhausted.
- Redeemable preference shares offer the benefit of flexibility to the company by giving them the option to buy back the shares, while this benefit is not offered by irredeemable preference shares.
- Redeemable preference shares give the shareholders certainty regarding the amount of the shares at the time of buy-back. Irredeemable preference shares also offer a level of certainty regarding the dividend but not of the share price itself.
- Dividend payments continue for as long as the redeemable preference shares are not bought back. With irredeemable shares, dividend payments continue till perpetuity.
- Redeemable preference shares are more popular as they offer flexibility to issuing companies. Irredeemable preference shares are scarcely used as they do not provide many benefits to the issuing company or the shareholders. In several jurisdictions, presently, irredeemable preference shares are being restricted.
Conclusion
Preference shares, thus, are shares or stocks issued by the company to distribute its dividends. Among these are redeemable and irredeemable preference shares. Redeemable preference shares are shares that can be redeemed or repurchased by the company if it is within the predetermined maturity date at a fixed rate. These preference shares offer the buy-back option to the company. Redeemable preference shares have no perpetuity, i.e., they can be repurchased at any time provided it is within the maturity period. They offer the company the flexibility of buying them back. This leads to further advantages like increased earning per share value and an increase in the share value for the shareholders. These shares are often used by venture capitalists since they provide an exit strategy for investments. Because of these benefits, they are popular.
This is not the case with irredeemable preference shares. They are not very popular and are rarely used. Irredeemable preference shares offer no benefits to the company or the shareholders. These are preference shares that cannot be bought back by the company and as such, have no clause attached at the time of their issuance. These shares have perpetuity i.e. they can last as long as the company is in existence and has active operations. They are extinguished only when the company is liquidated. Many jurisdictions have executed restrictions on the issuance of irredeemable preference shares. Being preference shares though, both redeemable and irredeemable preference shares benefit from the preferential right to the dividends. They also have a claim to the assets when a company undergoes liquidation. So, you see, there are benefits to being preferred or being a favourite. Even the market attests to it. And even though your parents tell you otherwise, keep a watch out for the subtle signs that favour you. If you find that the signs favour your sibling, your rant will have the backing of evidence.
References
- https://groww.in/p/types-of-preference-shares
- https://www.termscompared.com/redeemable-vs-irredeemable-preference-shares/
- https://fundsnetservices.com/redeemable-preference-shares
