Preference Capital

Definition: The Preference Capital is that portion of capital which is raised through the issue of the preference shares. This is the hybrid form of financing that has certain characteristics of equity and certain attributes of debentures.

Advantages of Preference Capital

• There is no legal obligation on the firm to pay a dividend to the preference shareholders.
• The redemption of preference shares is not distressful for a firm since the shares are redeemed out of the profits and through the issue of fresh shares (preference shares and equity shares).
• The preference capital is considered as a component of net worth and hence the creditworthiness of the firm increases.
• Preference shareholders do not enjoy the voting rights, and thus, there is no dilution of control.

Disadvantages of Preference Capital

• It is very expensive as compared to the debt-capital because unlike debt interest, preference dividend is not tax deductible.
• Although, there is no legal obligation to pay the preference dividends, when the payment is made it is done along with the arrears.
• The preference shareholder can claim prior to the equity shareholders, in case the dividends are being paid or at the time of winding up of the firm.
• If the company does not pay or skips the preference dividend for some time, then the preference shareholders could acquire the voting rights.

The preference capital is similar to the equity in the sense: the preference dividend is paid out of the distributable profits, it is not obligatory on the part of the firm to pay the preference dividend, these dividends are not tax-deductible.

The portion of the preference capital resembles the debentures: the rate of dividend is fixed, preference shareholders are given priority over the equity shareholders in case of dividend payment and at the time of winding up of the firm, the preference shareholders do not have the right to vote and the preference capital is repayable.