Conditions for Redemption of Preference Shares 2025

Fri Apr 11 2025

Investing is the most common technique of the 21st century to earn more irrespective of doing a 9-5 job. Today’s youth is indulging in stock market trends and analyzing trends to decide which could be the best investment plan. Preference shares are one of these. If you have preference shares and planning to redeem them, this article will tell you the conditions for redemption of preference shares. Well, Preference shares are one of the methods of investing in a company by securing your future loss. Now, the question is why only preference share? So, to understand it in a better way, keep reading this article, in which you will learn the preference shares definition, the method of redemption of preference shares, the types of preference shares, how to calculate the cost of preference shares, and many more.

Table of Content

🏦What are Preference Shares?

Preference shares hold features of both equity and debt shares, which is why they are also called preferred stock. As the name implies preference shareholders are given priority in distributing dividends from the company's profit, and right on the company's assets at the time of liquidation or wrapping up upon all the shareholders. Other than all these priorities and preferences these shareholders do not have any right to participate in managerial operations and no voting rights as well.

The following are the features and characteristics of Preference shares:-

Priority in Dividends: Among all the shareholders, even equity holders, preference shareholders are given priority in distributing dividends.
Priority at the Time of Liquidation: If the company is in liquidation or bankruptcy proceedings then Preference shareholders have the first right to accommodate the company's assets.
Limited Voting Rights: Preference shareholders have no or limited rights in voting, which means they cannot participate in choosing managerial authorities like the CEO, and can’t even participate in mergers.
Fixed Dividend: They have a fixed amount of dividends no extra benefits are given to these shareholders, irrespective of that ‘Participating Preference Shareholders’ can get dividends on extra surplus.
Hybrid Financing Instrument: They are also known as hybrid financing instruments due to possessing characteristics of both equity and debt.

📊Types of Preference Shares

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There are 9 types of Preference Shares according to different features and characteristics as Cumulative-Non-Cumulative, Participating-Non-Participating, Redeemable-Non Redeemable, Callable Option, and Adjustable Rate preference shares.

Here’s a detailed explanation of each type of preference shares for better understanding:-

Types of Preference Shares	Preference Shares Definition
Cumulative Preference Shares	These shareholders are entitled to arrear dividends and interest in the next year.
Non-cumulative Preference Shares	No arrears and dividends were paid to these holders for the previous year.
Participating Preference Shares	These shareholders have the right to take extra dividends in the company’s surplus if certain performance targets are reached.
Non-Participating Preference Shares	Only a fixed amount of dividend is paid which is mentioned in the brochure.
Redeemable Preference Shares	The company can redeem this kind of preference shares at any time.
Non-Redeemable Preference Shares	These shares cannot be redeemed before the fixed time as mentioned in the share brochure.
Callable Option Preference Shares	The company holds rights on these shares to make a call for a buyback of stocks before a predetermined time.
Adjustable Rate Preference Shares	The dividends on these shares are directly proportional to the interest rate in the market. Hence the dividend rate often fluctuates according to the company.

👍👎Advantages and Disadvantages of Preference Shares

With fixed dividends and priority in payouts over ordinary shares, these shares still have some advantages and disadvantages to their holders which need to be considered while making any decision.

Advantages	Disadvantages
Offers a more predictable income stream compared to ordinary shares. Have priority in dividend payments and the event of liquidation. Less risky than ordinary shares because of their fixed dividend and preferential treatment. Issuing preference shares can be a cheaper way for a company to raise capital than borrowing.	Have limited liability and are not personally liable for the company's debts beyond their investment. Shareholders do not have voting rights in the company. Have limited upside potential and do not benefit from company growth. There is no guarantee that the dividend will be paid to non-cumulative preference shareholders.

📜Conditions of Redemption of Preference Shares

To redeem preference shares, they must be fully paid, redemption can occur from company profits or fresh share issue proceeds, and a sum equivalent to the nominal value of redeemed shares must be transferred to a Capital Redemption Reserve Account.

Here are the conditions for redeeming preference shares, according to Section 55 of the Companies Act, 2013:

According to section 55 only fully paid-up preference shares can be redeemed.
The source of redemption is either from the company's profit, issue of fresh shares or from CRR.
If redemption occurs out of the company's profits, a sum equivalent to the nominal value of the shares to be redeemed must be transferred to a Capital Redemption Reserve (CRR) Account.
The Capital Redemption Reserve Account can be used to pay up unissued shares of the company to be issued to members as fully paid bonus shares.
At the time of redemption of shares, if there is any premium left for the payment, then it needs to be clear first from the company's profit.
The company is liable to redeem preference shares within a period not exceeding 20 years from the date of their issue.
Any redemption of preference shares should be notified (in Form No. 5) with the requisite filing fee to the Registrar of Companies within 30 days of the date of redeeming.

🧮How to Calculate Cost of Preference Shares

The cost of preference shares represents the return a company needs to provide to investors for holding these shares, essentially the cost of using that capital.

Cost of Preference Shares (kp) = (Annual Dividend (DP) / Net Proceeds (NP)) * 100

DP stands for annual dividend per share
NP refers to the net proceeds from the issue of preference shares

Example: If a company issues preference shares with an annual dividend of ₹5 per share and the net proceeds are ₹100 per share, the cost of preference shares would be (5/100) * 100 = 5%.

Importance: Understanding the cost of preference shares is crucial for financial decision-making, as it helps companies determine the overall cost of capital and make informed investment decisions.

🔄Methods of Redemption of Preference Shares

There are numerous methods for redeeming preferred shares like purchasing own shares by the company, from CRR, from company capital, and many more. Below is a detailed explanation of the methods of redemption of preferred shares:-

1. Redemption from Profits: The company can directly redeem shares from the earned profit. If the company is redeeming shares from its earned profit it means the company is doing well and the purpose of redemption might be to increase the capital.

2. Redemption Through CRR: At the time of issue of preference shares, the company is liable to set a Capital Redemption Reserve to distribute profits, hence CRR could be one of the sources to redeem shares.

3. Redemption through a Fresh Issue of Shares: The issue of fresh shares could be one of the options. Through this previous shares of the holders were replaced with new ones. This method helps the company to maintain its equity capital.

4. Redemption out of Capital: This method of redemption is the last option for the companies if the profits and reserves are not enough to cover. Most companies do not follow this method of redemption as it will have a negative impact on the capital structure.

5. Purchase of Own Shares: Buying own shares is the most cost-effective option and way more beneficial in certain situations. Companies opt for this option when the market price of a share is more favourable than the redemption value.

🤔Reasons for Preference Shares Redemption

Redeeming preference shares includes different reasons like enhancing capital structure, financial position, boosting investor's confidence, and many more. Here are the following reasons why a company might choose to redeem preferred shares:-

Capital optimization is one of the most important reasons for the redemption of preference shares.
To enhance the company’s financial position by balancing the debt-to-equity ratio.
To improve the financial ratios, such as earnings per share (EPS) which helps to make the company more attractive to investors.
Conversion of preference shares into debt can be more tax-efficient, which further helps in the tax reductions.
To boost the investor’s confidence in the company. If the company is redeeming shares from its profits then it is a signal that the company is confident about its cash flows and financial health.
Some of the preference shares hold high dividend rates, hence if the company decides to reduce the cost, then redemption of shares could be possible.
Most of the preference shares have a predetermined date of redemption, so it could be the reason for the redemption of shares.

✅Conclusion: Redeem Preference Shares: Make the Right Decision with Collegehai

With this complete information about preference shares and their conditions of redemption, it is now clear that preference shares are the most suitable and beneficial way to invest in a company. With preference shares, a shareholder can have priorities at the time of risk and have the potential to increase the earnings as well by converting them into common shares or could take participating preference shares.

According to section 55 of the Companies Act 2013, a shareholder has many options to redeem its shares through, the company’s profit, out of capital, or even can buy new shares. Preference shares provide a safe zone for both the company and its shareholders.

You can learn more about the investment plans and which shares could be the best choice for your retirement plan with the collegehai.com team.

❓Frequently Asked Questions(FAQ)

1. What are the conditions for the issue of preference shares?

To issue preference shares, a company must ensure its articles of association authorize it, obtain shareholder approval through a special resolution, and have no outstanding defaults in redeeming existing preference shares or paying dividends

2. What are the conditions for redemption of debentures?

To redeem debentures, companies must invest or deposit at least 15% of the debentures' face value maturing in the next financial year, in specified securities, by April 30th of the current year, as per Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014.

3. How does the redemption process for preference shares work?

Redemption of preference shares involves a company repurchasing its issued preference shares from shareholders, usually at a predetermined date and price, effectively removing them from circulation and returning the investment value to shareholders.

4. How do shareholders benefit from redeemable preference shares?

Redeemable preference shares offer investors a fixed income stream through dividends, with the added benefit of a predetermined redemption date and price, ensuring a return of principal after a set period.

5 . How does the Redemption of Preference Shares impact a company?

Redeeming preference shares impacts a company by requiring it to repay the investment to shareholders, potentially restructuring capital, and potentially impacting cash flow and financial flexibility.

6 . Who can redeem preference shares?

7 . Who is eligible for preference shares?

Preference shares, also known as preferred stock, are typically issued to investors who seek a more stable income stream and are given priority in dividend payments and asset distribution in case of liquidation, compared to common shareholders.

8. What are redeemable preference shares?

Redeemable preference shares are a type of preference share that the issuing company can buy back (redeem) at a predetermined date or under specific conditions, offering investors a fixed dividend and a guaranteed return of principal after a set period.

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