Redeemable preference shares are a type of share that can be bought back by the issuing company after a specified period. These shares offer fixed dividends and are repurchased by the company at an agreed date or upon maturity.
What Is Redeemable Preference Share?:
Redeemable preference shares are a type of preferred stock that the issuing company agrees to repurchase after a specific period. They offer fixed dividends to shareholders, providing a steady income stream until the company buys back the shares.
These shares are generally issued with a predefined redemption date or maturity period, allowing the company to return the invested capital to shareholders. The buyback of these shares helps the company manage its capital structure efficiently. Unlike ordinary shares, redeemable preference shares do not grant voting rights, but they are prioritized over equity shares for dividend payments and in case of liquidation.
Redeemable Preference Shares Example
An example of redeemable preference shares could involve a company issuing 1,000 shares at ₹100 each, with a fixed annual dividend of 8%. The company agrees to repurchase these shares after 5 years at the original price, providing both dividends and principal repayment.
Suppose an investor buys 1,000 redeemable preference shares, investing ₹1,00,000. The investor receives an 8% dividend, earning ₹8,000 each year for 5 years, totaling ₹40,000 in dividends. After 5 years, the company repurchases the shares for ₹1,00,000, returning the principal. In total, the investor earns ₹1,40,000, which includes both dividends and the original investment.
How Are Preference Shares Redeemed?
As an investor, preference shares are redeemed when the issuing company buys them back from you after a specified period. The redemption occurs according to the terms agreed upon at issuance, such as the date and price for repayment. Steps to redeem preference shares as an investor:
- Understand the Redemption Terms
As an investor, it’s important to know the terms set when the shares were issued. This includes the agreed-upon redemption period, the price at which the shares will be bought back, and any conditions that apply.
- Wait for Redemption Notification
Before the redemption date, you will receive a notice from the company informing you about the upcoming redemption. The notice will include details such as the redemption date and the amount you will receive for your shares.
- Receive Principal Payment
On the redemption date, the company will repay you the principal amount for your preference shares. This payment will be made based on the original terms, and the funds will be credited directly to your bank or trading account.
- Stop Earning Dividends
Once the shares are redeemed, you will stop earning dividends on those preference shares. The redemption marks the end of your investment in those shares, and the dividends will cease going forward.
- Update Investment Records
As an investor, you should update your investment portfolio records to reflect the redemption. Ensure that you have received the correct amount for your shares and adjust your financial planning accordingly.
Redeemable Preference Shares Formula
The formula for redeemable preference shares is (Annual Dividend × Number of Years) + Principal Repayment. It involves calculating the total return on redeemable preference shares by summing the dividends received over the holding period and the principal repaid at redemption.
Let’s understand this with an example. If an investor purchases 500 redeemable preference shares with a face value of ₹200 per share, receiving an annual dividend of 10%, the total investment is ₹1,00,000 (500 × ₹200). The annual dividend is ₹20,000 (10% of ₹2,00,000), and after 3 years, the investor earns ₹60,000 in dividends. Upon redemption, the principal of ₹1,00,000 is repaid, resulting in a total return of ₹1,60,000.
Difference Between Redeemable and Irredeemable Preference Shares
One primary difference between redeemable and irredeemable preference shares is that redeemable shares are repurchased by the company after a specific period, while irredeemable shares do not have a fixed redemption date and may remain outstanding indefinitely unless otherwise agreed upon.
| Parameter | Redeemable Preference Shares | Irredeemable Preference Shares |
| Redemption | Repurchased by the company after a set period | No fixed redemption date |
| Investment Period | Limited, with a predetermined buyback date | Perpetual, may not be bought back by the company |
| Dividend Payments | Fixed dividends until redemption | Fixed dividends continue indefinitely |
| Risk Level | Lower risk due to predictable redemption | Higher risk, as shares may remain unredeemed |
| Capital Repayment | Principal returned to investor at redemption | No guaranteed return of principal |
| Company Control | Allows company to control capital structure | No immediate impact on company capital |
Advantages of Redeemable Preference Shares
The primary advantage of redeemable preference shares is that they provide companies with flexibility in managing their capital. By redeeming shares after a certain period, companies can adjust their capital structure and reduce liabilities when financially feasible.
Other key advantages of redeemable preference shares:
- Fixed Dividend Payments: Investors benefit from regular, fixed dividend payments, providing a steady income stream. This makes redeemable preference shares appealing to investors seeking stability and predictable returns without the risk associated with common shares.
- Lower Investment Risk: Compared to common shares, redeemable preference shares carry less risk. Investors know they will receive their principal back when the shares are redeemed, reducing uncertainty and potential losses from fluctuating share prices.
- Priority in Liquidation: In case of liquidation, redeemable preference shareholders are prioritized over common shareholders. This ensures that preference shareholders are more likely to receive payment of their dividends and principal before any returns are made to equity shareholders.
- Attractive for Investors: Redeemable preference shares can attract risk-averse investors, offering fixed returns and eventual principal repayment. This can help companies raise capital more easily compared to issuing common shares, which are more volatile.
- Improved Financial Flexibility for Companies: Companies can redeem shares when market conditions are favorable, allowing them to lower their financial obligations. This flexibility enables better financial planning and improved control over long-term capital structure.
Disadvantages of Redeemable Preference Shares
One main disadvantage of redeemable preference shares is that they do not offer voting rights to shareholders. This means investors have no say in company decisions, limiting their influence on matters like board appointments or strategic corporate actions.
Other key disadvantages of redeemable preference shares:
- Limited Capital Appreciation: While redeemable preference shares provide fixed dividends, they lack the potential for significant capital gains. Investors will only receive the principal amount upon redemption, missing out on the upside growth that common shareholders might experience through rising stock prices.
- Higher Cost for Companies: Redeemable preference shares often carry higher dividend rates compared to bonds or common shares, making them a more expensive financing option for companies. The obligation to pay dividends and redeem the shares can strain a company’s cash flow.
- Obligatory Redemption: Companies are required to redeem these shares at a fixed date, which can put pressure on their financial resources. If the company’s financial situation worsens, the mandatory redemption of shares may further weaken its cash reserves and overall financial health.
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Redeemable Preference Shares – Quick Summary
- Redeemable preference shares are shares that a company can buy back after a specific period, offering fixed dividends and stable returns for investors. They are commonly used to manage capital effectively.
- These shares offer fixed dividends and are repurchased by the company at a predetermined date, ensuring that investors receive their principal back after a certain period. However, investors do not have voting rights.
- For example, an investor purchasing 1,000 redeemable preference shares at ₹100 each with an 8% dividend earns ₹8,000 annually and gets the ₹1,00,000 investment back after 5 years, totaling ₹1,40,000.
- Preference shares are redeemed when the company repurchases them at the agreed-upon time. Investors receive their principal back, and dividend payments stop once the shares are redeemed.
- The total return formula includes annual dividends plus the principal. For instance, if you receive ₹20,000 in dividends each year for 3 years and the principal of ₹1,00,000, the total return is ₹1,60,000.
- Redeemable shares have a set redemption date, while irredeemable shares have no fixed date, potentially remaining outstanding forever, offering less control over capital management for companies.
- The key advantage of redeemable preference shares is that they offer fixed dividends, providing predictable and stable returns for investors.
- One of the major disadvantages of redeemable preference shares is that they do not offer voting rights, limiting investor influence in company decisions.
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Redeemable Preference Shares Meaning – FAQs
Redemption of preference shares refers to the process where a company repurchases its preference shares from investors at a predetermined date. The company returns the principal to shareholders, and dividends cease after the shares are redeemed.
Any company, public or private, can issue redeemable preference shares to raise capital. The terms of redemption, including the timeframe and dividend rate, are specified during issuance, subject to regulatory guidelines.
An example of a redeemable share is when a company issues preference shares with a face value of ₹100, offering a 7% annual dividend. After 5 years, the company repurchases the shares at ₹100, returning the principal to investors.
The value of redeemable preference shares is calculated by summing the present value of future dividend payments and the principal repayment at redemption. It considers factors like dividend rate, redemption period, and prevailing interest rates.
Only the issuing company has the authority to redeem its redeemable preference shares. The company repurchases the shares from shareholders on the specified redemption date, as per the terms set at issuance.
Redeemable preference shares are an asset for investors, providing fixed dividends and the return of the principal upon redemption, offering stable returns. For company, redeemable preference shares are a liability, requiring dividend payments and eventual repurchase, creating a financial obligation.
Generally, redeemable preference shares are not convertible into equity unless explicitly stated during issuance. Their primary purpose is to provide fixed returns and eventual redemption, not to grant ownership in the company.
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