Definition
Redeemable preference shares are a type of preferred stock that the issuing company has the right to redeem or buy back at a certain price and specific time in the future. The redemption can be either at the option of the shareholder or the company. The terms of the redemption, including the price and date, are defined at the time of issuance.
Key Takeaways
- Redeemable Preference Shares refer to a type of preference shares that a company can buy back or redeem after a fixed period or on a specific date, offering investors a guaranteed exit route.
- These shares offer benefits to both parties, serving as an effective fund-raising tool for businesses, while providing investors higher claim on earnings and assets, along with fixed returns.
- However, they carry more risk than debt securities as their repayment in case of company liquidation is prioritized after bondholders and creditors, but before common shareholders.
Importance
Redeemable Preference Shares are crucial in the financial landscape as they offer a unique combination of advantages to both the company and the investors. Companies issue these shares to raise capital without increasing their loan liability, thus maintaining a healthy debt-equity ratio.
Simultaneously, for investors, these shares provide a fixed dividend irrespective of the company’s profit, and also a priority in repayment if the company faces liquidation. Moreover, the ‘redeemable’ feature offers an opportunity for investors to sell the shares back to the company after a pre-determined period.
Hence, the importance of Redeemable Preference Shares lies in their balance of benefits – ensuring companies’ finance needs are met while providing investors with secure returns and amplified assurance.
Explanation
Redeemable preference shares have a fundamental role in corporate finance, offering a potentially valuable financing option for companies. Often, companies use redeemable preference shares as part of their strategic funding, for expansion, new project development, or even for settling existing obligations. They may prefer issuing redeemable preference shares instead of common shares to avoid diluting the ownership of current common shareholders.
Rewarding the preference shareholders with fixed dividends, typically higher than ordinary shares, are an attractive feature of this instrument. Moreover, these shares often provide companies with financial flexibility. Since these shares are redeemable, a company can issue them with the intention of buying them back in the future.
This might be a beneficial strategy for the company when it currently needs funds but anticipates a cash influx in the future. Additionally, redeeming the shares can be a method to redistribute profits back to investors without issuing dividends, especially for companies seeking to manage cash flow or preserve retained earnings. In effect, through redeemable preference shares, companies can strike a balance between attracting investment and maintaining control and financial flexibility.
Examples of Redeemable Preference Shares
Case of Unilever: Unilever, a multinational consumer goods company, has issued redeemable preference shares to its investors with a fixed dividend rate. After a set period, Unilever has the right to buy back these shares or the shareholder has the right to sell them back to the company. This provides Unilever with the flexibility to reduce its share capital when required.
Redrow Plc: Redrow, a UK-based housebuilding company, had issued redeemable preference shares that the company had the right to buy back at a fixed price on certain future dates. These shares provided extra capital for the company when needed, and also allowed the company an opportunity to reduce its share capital in lean times.
Warren Buffet’s investment in Goldman Sachs: During the financial crisis in 2008, Warren Buffet’s Berkshire Hathaway invested $5 billion in Goldman Sachs, purchasing redeemable preference shares. These shares included a 10% dividend and the option for Goldman to buy them back at a premium in the future. This illustrated a robust example of using redeemable preference shares during a financial downturn.
FAQ for Redeemable Preference Shares
What are Redeemable Preference Shares?
Redeemable Preference Shares are a type of preference shares that can be redeemed or repurchased by the issuing company after a certain period of time.
What is the benefit of owning Redeemable Preference Shares?
Owners of Redeemable Preference Shares are entitled to a fixed dividend before any dividend is paid to the holders of ordinary shares. In addition, they have the right to receive their capital back before ordinary shareholders if the company is liquidated.
When can Redeemable Preference Shares be redeemed?
The redemption or repurchase of Redeemable Preference Shares by the issuing company can happen after a predetermined fixed period or on a specific future date, as per the terms issued at the time of initial share purchase.
Do Redeemable Preference Shares owners have voting rights?
In general, holders of preference shares do not have voting rights in the company. However, if their dividends are not paid, they may gain voting rights. The specifics will be outlined in the terms and conditions of the specific share class.
Related Entrepreneurship Terms
- Dividend Rights: These refer to the entitlement that redeemable preference shareholders have to receive a fixed dividend before any other type of shares.
- Redemption Premium: This refers to the extra amount above the par value that a company may need to pay when buying back redeemable preference shares.
- Equity Capital: This is the fund raised by issuing shares in return for cash or other considerations. Redeemable preference shares are part of a company’s equity capital.
- Liquidation Preference: This is the priority given to redeemable preference shareholders when a company is liquidated. They are usually paid before ordinary shareholders.
- Share Capital: This is the total value of shares that a company can issue. Redeemable preference shares contribute to a company’s share capital.
Sources for More Information
- Investopedia: This educational website provides a wealth of information on financial concepts such as Redeemable Preference Shares.
- Accounting Tools: Another educational resource, Accounting Tools offers easy-to-understand explanations of various financial terms and concepts.
- The Balance: With an extensive library of articles on finance, The Balance is a good source of information about Redeemable Preference Shares.
- Corporate Finance Institute: The Corporate Finance Institute website offers online training and certification programs, and their extensive educational resources can provide in-depth information on Redeemable Preference Shares.
