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How Does Company Insolvency Affect Preference Shares?
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Preference shares and how are these important in company insolvency
There are two main types of shareholders in a limited company: ordinary shareholders and preference shareholders. While ordinary shareholders are issued with “common” stock in a company, preference shareholders will receive “preferred” stock. Preference shares are most commonly issued in larger companies, particularly those which have received outside investment.
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Both types of shareholders have a stake in the company and are able to receive dividends, however, there are also some key differences between the two. Preferred shareholders are not entitled to vote at shareholder meetings, meaning key decisions when it comes to the running of the company can be made without them.
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However, there are some distinct advantages to holding preferred stock. Firstly, preferred shareholders tend to have a fixed dividend which is not linked to the performance of the company. This makes it a less risky investment for investors as they have an element of certainty over the dividends they can hope to extract from the company at designated times although they will not be able to benefit from any increases to dividend payments if the company continues to be successful over a prolonged period of time. Despite being granted a fixed amount, it must be said that this does not guarantee the shareholder will receive dividends at regular intervals. Other shareholders could decide that no dividends will be issued during a certain period; this would mean neither preferred nor ordinary shareholders would receive anything. What is important to remember is that preferred shareholders must receive their dividend before those holding common stock. It is not possible for an ordinary shareholder to receive a dividend yet preferred shareholders miss out.
If dividends are not issued during a period then these can be rolled over (for cumulative preferred shareholders) and be paid when the next lot of dividends are announced. Some preferred shareholders are non-cumulative, meaning if a dividend pay-out is missed, this is not rolled over and instead the shareholder misses out on this payment.
In the event of company liquidation, the benefit of holding preferred stock again becomes apparent. Should the company find itself experiencing financial difficulties and makes the decision to enter a formal liquidation procedure, preferred shareholders will rank before ordinary shareholders when it comes to receiving payment. However, all shareholders will have to wait until all secured, unsecured, and preferential creditors have been paid before they can expect to receive anything. Unfortunately in an insolvent liquidation, there is very often no money left in the company once these liabilities have been settled.
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