What are preference shares during insolvency?

What are preference shares?Preference shares during insolvency rank preferred shareholders before ordinary shareholders when it comes to receiving any type of payment

Despite preference shares being considerably less common than ordinary shares, they offer some distinct advantages.

The benefits of insolvency become apparent when a company is insolvent.

In the aftermath of the Covid-19 lockdowns, UK firms now have temporary insolvency restriction protections ending as they try to get back to business as usual. 

Therefore, more of those businesses struggling financially to recover from the pandemic could ultimately go out of business.

How do preference shares work during insolvency? We’ll talk about what preference shares are, how they are handled during insolvency, and what happens afterwards.

What are preference shares?

Preference shares are a form of stock that pays out dividends usually fixed to shareholders.

A preference share is redeemable at any time, so they can be redeemed at any time, but they do not normally confer voting rights. 

Preference shares can be divided into four types:

  • Cumulative – dividends are much more likely to be paid, even if they have rolled over from an earlier period 
  • Non-cumulative – dividend payments are not paid retrospectively if no dividend is issued, in contrast to cumulative shares 
  • Participating – determine dividend payments based on specific performance indicators
  • Convertible – Allow the holders of preference shares to convert them to common shares

What is the difference between ordinary shares and preference shares?

Preference shares vs ordinary shares

Stock, or proportional ownership of a company, is also represented by ordinary or common shares.

Ordinary shares, however, do not pay dividends, as the board of directors is in charge of choosing whether or not to pay them.

Ordinary shares also include voting rights, in contrast to preference shares.

For insolvency cases, preference shares have a key benefit, which we will explore in a moment. Ownership of ordinary shares can yield a greater profit than ownership of preference shares, which have fixed rewards.

Insolvency and preference shares

Insolvent companies are those that:

  1. Because of cash flow issues, it cannot pay its debts on time
  2. Balance sheet shows more debt than assets
  3. Legal action has been taken, such as a winding-up petition

If a company goes into liquidation, there may not be sufficient funds to pay back the holders of preference shares.

It’s important to consult an experienced insolvency practitioner (IP) as soon as possible if your company is insolvent.

Choosing an IP could lead to an insolvent company entering into administration, a company voluntary arrangement (CVA), or a creditors’ voluntary liquidation (CVL). 

As a result of a liquidation, preference shares are treated as what they are.

Liquidation preference and preferred stock

During a liquidation, a priority list is established in terms of whose money is returned first.

Depending on the agreements in place and the type of shares issued, the different parties are ranked in order of priority.

All secured creditors, unsecured creditors, and preferential creditors must be repaid in the first instance.

Then, if there are still funds remaining, the shareholders will also be repaid.

Specifically, preferred stock owners have a higher liquidation preference than holders of ordinary stock.

Preferred stock liquidation value

Those with preference shares will receive the preferred stock liquidation value when they are repaid under this scenario.

Money may be available if the company has been liquidated plus unpaid dividends. 

As this article outlined what to expect with preference shares when a company becomes insolvent, we hope it has clarified the definition of preference shares.

Even though preference shareholders receive their cash back before those who hold ordinary shares, it still depends on how much money is left in the liquidated business.

Feel free to contact us for a no-obligation chat if you have any questions about preference shares or are concerned that your company is insolvent.

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