Redeemable Preference Shares

Redeemable Preference Shares

Redeemable preference shares are a type of stock that can be bought back by the issuing company at a specific future date, providing investors with fixed dividend payments until they are redeemed.

Contents:

What Is Redeemable Preference Share?

Redeemable preference shares are a funding tool for companies, offering fixed dividends and a buy-back option on a set date. Investors get regular income and a clear exit, but the pre-set terms can influence the investment’s future worth.

In a detailed view, redeemable preference shares are often issued when companies need capital but want to retain the option to repurchase the shares in the future. This feature benefits companies as it provides flexibility in managing their capital structure. 

For investors, these shares offer fixed dividends, typically higher than common stock dividends, and a predetermined exit strategy. However, the price and redemption terms are set at the time of issuance, which can impact the investment’s future value.

Redeemable Preference Shares Example

A standard example of redeemable preference shares is a corporation offering shares with a pre-defined buy-back date and dividend rate, like an annual 6% return, redeemable after 5 years.

Consider ‘XYZ Corporation,’ an Indian company, issuing redeemable preference shares with a 6% annual dividend rate. These shares are scheduled for redemption after 5 years at their original issue price. Investors who buy shares worth INR 100,000 will receive an annual dividend of INR 6,000. After 5 years, XYZ Corporation will repurchase these shares at the initial investment amount of INR 100,000.

Redeemable Preference Shares Formula

The basic formula is: Redemption Value = Nominal Value of Shares + Any Accumulated Dividends. 

  • Nominal Value of Shares: This is the initial value at which the shares are issued, often called the face value or par value.
  • Accumulated Dividends: These are dividends that have been declared but not yet paid to shareholders over the time they hold the shares.

The redemption value is a crucial figure for investors, representing the total payout at the end of the investment period. For example, in case of XYZ Corporation, suppose an investor holds redeemable preference shares with a nominal value of INR 100,000. Over the investment period, let’s say accumulated dividends amount to INR 15,000. The redemption value at the end of the period would be INR 115,000 (INR 100,000 nominal value + INR 15,000 accumulated dividends). 

This total payout reflects both the capital invested (nominal value) and the dividends earned, representing the comprehensive return the investor receives upon redemption of these shares.

How Are Preference Shares Redeemed?

Redeemable preference shares are redeemed when the issuing company buys back these shares from shareholders at a predetermined price on a specified date. This process effectively cancels the shares, returning the initial investment to the shareholders.

  • Announcement of Redemption: The company announces the redemption details, including the date and price, typically outlined in the share issuance terms.
  • Calculation of Redemption Amount: The total amount to be paid to shareholders is calculated based on the redemption price per share and the number of shares held.
  • Funding the Redemption: The company arranges funds for redemption, which might come from profits, a fresh issue of shares, or borrowing.
  • Payment to Shareholders: On the redemption date, shareholders are paid the redemption amount, which could be in cash or equivalent.
  • Cancellation of Shares: After payment, the redeemed shares are cancelled and cease to exist as part of the company’s equity structure.
  • Legal and Regulatory Compliance: The company completes any legal or regulatory requirements associated with the redemption, ensuring compliance with financial regulations.

Difference Between Redeemable And Irredeemable Preference Shares

The main difference between redeemable and irredeemable preference shares is that redeemable preference shares can be repurchased by the issuing company at a set date, whereas irredeemable shares lack this and stay with the investors forever but may be repurchased under specific, exceptional conditions set by the issuing company. 

FeatureRedeemable Preference SharesIrredeemable Preference Shares
RedemptionCan be bought back on a predetermined dateNo fixed date for redemption; can remain forever
Investor Exit StrategyProvides a clear exit strategy for investorsLacks a predetermined exit option for investors
Dividend RateOften higher to compensate for the redemption featureMay vary, but generally lower due to perpetual nature
Company FlexibilityAllows companies to adjust capital structure over timeLimits company’s flexibility in capital restructuring
Market ResponseMarket price influenced by the proximity to redemption dateMarket price more influenced by interest rate changes and company performance
Risk ProfileGenerally lower risk due to the redemption featureHigher risk due to the indefinite holding period
Legal and RegulatoryBound by specific regulations regarding redemptionSubject to general regulations without specific redemption rules

To understand the topic and get more information, please read the related stock market articles below.

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Redeemable Preference Share Meaning – Quick Summary

  • Redeemable Preference Shares are stocks that can be repurchased by the issuing company at a future date, offering fixed dividends until redemption.
  • Redeemable Preference Shares are useful for companies needing capital flexibility and offering investors fixed dividends with a clear exit strategy.
  • An example of a redeemable preference share is when a corporation, ABC LTD., issues shares with a 6% annual return, redeemable after 5 years, benefiting both the company and the investors.
  • The formula for redemption value is Redemption Value = Nominal Value of Shares + Any Accumulated Dividends.
  • The redemption process of redeemable preference shares occurs by issuing company repurchases shares at a predetermined price on a specified date, concluding the investment and returning the initial amount to shareholders.
  • The main difference between redeemable and irredeemable preference shares is that redeemable preference shares can be bought back by the company at an agreed time, while irredeemable shares stay with the investors forever unless the company chooses to buy them back under special circumstances.
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Redeemable Preference Shares – FAQs

1. What Is Redeemable Preference Share?

A redeemable preference share is a type of stock that can be repurchased by the issuing company at a predetermined date, offering a fixed dividend until it’s redeemed.

2. What is an example of a redeemable share?

An example of a redeemable share is a share issued by a company with a specific redemption date, like 5 years from issuance, offering a 6% annual dividend until it’s repurchased by the company.

3. Who can issue redeemable preference shares?

Redeemable preference shares can be issued by companies seeking flexible financing options, allowing them to raise capital with the ability to repurchase shares in the future.

4. Why are redeemable shares issued?

Companies issue redeemable shares to raise capital while retaining the option to buy back the shares, providing them flexibility in managing their equity structure and financial planning.

5. Is redeemable preference shares asset or liability?

For the issuing company, redeemable preference shares are considered a liability due to the obligation to pay dividends and redeem them in the future. From an investor’s perspective, they are an asset offering fixed dividends and a predetermined exit strategy through redemption.

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