Issuing share capital is one of the key fund-raising modes adopted by companies. Share capital is broadly of two types – equity share capital and preference share capital. While both equity and preference shareholders receive dividend in the form of returns, preference shareholders get priority over equity shareholders for receipt of dividends and claim to assets on liquidation. Within preference shares, there are several different types depending on certain key characteristics.
This article looks at meaning of and differences between two types of preference shares – redeemable and irredeemable preference shares.
Definitions and meanings
Redeemable preference shares:
Redeemable preference shares are those preference shares that have a predetermined redemption clause at the time of their issue. In the case of these shares, a redemption price/price range is predetermined and noted in the issue prospectus. The issuing company has a right to redeem i.e., buy back these shares at the predetermined redemption price at any time before the redemption period specified.
The primary purpose of issuing redeemable preference shares is to give companies flexibility when they wish to buy-back shares. Let us understand this with an example.
M/s ABC Inc. has issued redeemable preference shares of face value $100 each. These shares have a redemption clause with a redemption period of 20 years and a redemption price of $200 each. Say, after 10 years, ABC Inc. wishes to buy back some of its shares. The market price per share at this point is $220. ABC Inc. can thus redeem its issued redeemable preference shares at a lower price of $200 as compared to the open price available in the market.
Irredeemable preference shares:
Irredeemable preference shares are those preference shares which can only be redeemed at the time of liquidation of the company. These shares do not have any incorporated clause with respect to their redemption and thus cannot be bought back at the choice of the issuing company.
Irredeemable preference shares remain in existence so long as the company is in existence i.e., they do not have any predetermined maturity period and are perpetual in nature. These shares are only extinguished in the event that the company goes into liquidation and the shareholders receive share of assets in exchange of extinguishment of shares.
Irredeemable preference shares become a permanent liability for the issuing company, in that they are obligated to pay dividend on these shares for perpetuity.
Although these shares exist in theory, several jurisdictional laws have imposed restrictions on issue of irredeemable preference shares.
Difference between redeemable and irredeemable preference shares:
The difference between redeemable and irredeemable preference shares has been detailed below:
- Redeemable preference shares are those preference shares that can be bought back by the issuing company within its predetermined maturity period.
- Irredeemable preference shares are those preference shares that cannot be bought back by the issuing company till the company is a going concern and in existence.
2. Option to buy-back
- Redeemable preference shares give companies the option to buy back at any time within the maturity period, by giving notice to the shareholders.
- Irredeemable preference shares do not give the issuing company any option to buy back the shares.
- Redeemable preference shares do not exist for perpetuity- they remain in existence till their maturity which is pre-determined and specified at the time of their issue.
- Irredeemable preference shares exist for perpetuity i.e.: till the issuing company is in existence and not wound up.
4. Extinguishment of shares
- Redeemable preference shares can be extinguished at any time within the maturity period.
- Irredeemable preference shares can only be extinguished at the time of liquidation.
5. Benefit to issuing company
- Redeemable preference shares offer the benefit of flexibility to the issuing company as they can be bought back at a predetermined price that may be much lower than the prevailing market price, at the option of the company.
- Irredeemable preference shares as such do not offer any such benefit to the issuing company.
6. Certainty for shareholders
- Redeemable preference shares offer certainty to its holders with respect to the amount that they would receive at the time of buy-back of their shares.
- Irredeemable preference shares although offer certain degree of certainty with respect to receipt dividend (as for all types of preference shares), they do not offer any certainty with respect to return of the share price itself. When the company goes into liquidation, they will receive a claim on assets whose value will be determined by the financial condition of the issuing company at that time.
7. Continuity of dividend payments
- Dividend payments on redeemable preference shares continue only till the shares are not bought back.
- Dividend payments on irredeemable preference shares continue for perpetuity as the shares also exist for perpetuity.
- Redeemable preference shares are more popular and more commonly found as they provide flexibility to issuing companies as well as certainty to the shareholders. It is often opted for by venture capitalists as they provide a predetermined exit route for their investments.
- Irredeemable preference shares are comparatively sparingly used as they offer limited benefits to both the issuing company and shareholders. In fact, several jurisdictions now prohibit or restrict the right of companies to issue irredeemable preference shares.
The key point of difference between redeemable and irredeemable preference shares is their ability to be bought back by the issuing company. They however do still have several similar features which are common to preference shares. Being preference shares, both redeemable and irredeemable shares enjoy preferential right to dividend as well as to claim of assets at the time of liquidation when compared to equity. Their position falls between debt instruments and equity shares with respect to their obligation for repayment.