# Understanding Preference Shares: Types and Benefits of Preferred Stock

> **Definition**
>
> Preference shares or preferred stock are a class of stock that receive dividends before common stock.

## What Are Preference Shares?

Preference shares, often called [preferred stock](https://www.investopedia.com/terms/p/preferredstock.asp), are company shares with dividends paid to shareholders before common stock dividends. There are four main categories of preferred shares: cumulative, non-cumulative, participating, and convertible, each with different dividend rights and conversion options.

### Key Takeaways

*   Preferred shares offer advantages such as fixed dividends and priority over common stock dividends, making them attractive to risk-averse investors.
*   There are four main types of preference shares: cumulative, non-cumulative, participating, and convertible, each with distinct features affecting dividends and shareholder rights.
*   Cumulative preferred shares guarantee dividends, including any missed, whereas non-cumulative shares do not provide for unpaid dividends.
*   Participating preferred shares can offer additional dividends if certain conditions are met, while convertible preferred shares allow conversion to common shares under specified terms.
*   In case of bankruptcy, preference shareholders are prioritized over common shareholders in asset distribution, but rank below debt holders like bondholders.

![Preference Shares](https://www.investopedia.com/thmb/AjEGUJfSx8-yzEHEWJIBgRELPbk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Term-Definitions_preference-shares-718c73612ed149c181dd3a098ee9f438.jpg)

*— Investopedia / Jessica Olah*

## Detailed Explanation of Preference Shares

Preference shares fall under four categories: cumulative preferred stock, non-cumulative preferred stock, participating preferred stock and convertible preferred stock.

[Cumulative preferred stock](https://www.investopedia.com/terms/c/cumulative_preferred_stock.asp) requires the company to pay all past and present dividends to these shareholders before common shareholders receive theirs. While these dividend payments are guaranteed, they might not be paid on time. Unpaid dividends are assigned the moniker "dividends in arrears" and must legally go to the current owner of the stock at the time of payment. At times, additional compensation (interest) is awarded to the holder of this type of preferred stock.

> Quarterly Dividend = \[(Dividend Rate) x (Par Value)\] ÷ 4

> Cumulative Dividends per share = Quarterly Dividend x Number of Missed Payments

Non-cumulative preferred stockholders have no claim to unpaid or omitted dividends. If the company chooses not to pay dividends in any given year, the shareholders of the non-cumulative preferred stock have no right or power to claim such forgone dividends at any time in the future.

[Participating preferred stockholders](https://www.investopedia.com/terms/p/participatingpreferredstock.asp) can receive the standard dividends plus extra, depending on specific conditions. This additional dividend is typically designed to be paid out only if the amount of dividends received by common shareholders is greater than a predetermined per-share amount. If the company is liquidated, participating preferred shareholders may also have the right to be repaid the purchase price of the stock, as well as a pro rata share of the remaining proceeds received by common shareholders.

Convertible preferred stock lets shareholders change their shares into common shares after a certain date. Under normal circumstances, convertible preferred shares are exchanged in this way at the shareholder's request. However, a company may have a provision on such shares that allows the shareholders or the issuer to force the issue. How valuable convertible common stocks are is based, ultimately, on how well the [common stock](https://www.investopedia.com/terms/c/commonstock.asp) performs.

## What Are Preference Shares?

Preference shares, also known as [preferred shares](https://www.investopedia.com/terms/b/blankcheckpreferred.asp), are a type of security that offers characteristics similar to both [common shares](https://www.investopedia.com/terms/c/commonstock.asp) and a [fixed-income security](https://www.investopedia.com/terms/f/fixed-incomesecurity.asp). The holders of preference shares are typically given priority when it comes to any dividends that the company pays. In exchange, preference shares often do not enjoy the same level of voting rights or upside participation as common shares.

## What Are the Main Types of Preference Shares

There are four main types of preference shares: cumulative preferred, non-cumulative preferred, participating preferred, and convertible. Holders of cumulative preferred shares are entitled to receive dividends retroactively for any dividends that were not paid in prior periods, whereas non-cumulative preferred shares do not carry this provision. For this reason, cumulative preferred shares will generally be more expensive than non-cumulative preferreds. Similarly, participating preferred shares offer the benefit of additional dividends if certain performance targets are reached, such as company profits exceeding a specified level. Convertible preferreds, like [convertible bonds](https://www.investopedia.com/terms/c/convertiblebond.asp), allow the holder to convert their preference shares into common shares at a specified [exercise price](https://www.investopedia.com/terms/s/strikeprice.asp).

## What Happens if You Own Preference Shares in a Company That Goes Bankrupt?

If a company goes bankrupt, then the different securityholders in that company will have claim to the company’s assets. The order in which those securityholders receive their share of the assets will depend on the specific rights given to them in their security agreements. Preference shares, for instance, will generally have [priority over the common shares](https://www.investopedia.com/terms/p/perpetual-preferred-stock.asp), and will therefore be paid before the common shareholders. However, preference shares will generally have lower priority than [corporate bonds](https://www.investopedia.com/terms/c/corporatebond.asp), [debentures](https://www.investopedia.com/terms/d/debenture.asp), or other fixed-income securities.

## The Bottom Line

The benefits of preference shares include priority on dividend payments and asset claims in bankruptcy over common shares. However, these shares are of lower priority than bonds and other fixed-income investments in the event of the company filing for bankruptcy.

Preferred shareholders also differ from common shareholders in that they lack voting rights.

The four main types of preference shares are cumulative, non-cumulative, participating, and convertible, and are suitable for risk-averse investors seeking stable returns. If you're considering purchasing preference shares, it's best to consult a financial advisor to ensure they align with your investing goals and financial circumstances.

> **Article Sources**
>
> 1.  PWC. "[7.7 Preferred Stock Dividends](https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financing_transactio/financing_transactio_US/chapter_7_preferred__US/77_preferred_stock_d_US.html)."
>     
> 2.  U.S. Securities and Exchange Commission. "[What Are Stocks?](https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks)"