Preference shares wording

Preference shares provide a way of giving certain shareholders a share of the company’s profits. Our model sets out sample wording that can be added to your articles setting out the most common preference share rights.

What are preference shares?

The rights of particular classes of share are described by comparison to those attached to ordinary shares. In the case of preference shares, they have rights in preference to ordinary shares. Usually, they are entitled to the first slice of dividends and any repayment of capital.

Usual rights

Preference shares usually carry preferential rights to income (dividends) and capital, meaning that they are entitled to receive their cut before the other shareholders. As preference shares are used as a way of enabling shareholders to participate in the company’s profits, they do not usually carry the “managerial” rights, such as attending meetings or voting. They are usually only given the right to do so where the company owes them dividends or a return of capital payment. This gives them a means of investigating the reasons for the failure and, if necessary, enforcing their rights.

Note that the dividend rights are usually cumulative, i.e. if the company fails to pay the dividend, the right rolls on to the next year. If this is not desired, the model should be amended accordingly.

The rights should be set out in the company’s articles. Our model gives suggested wording that can be inserted into the articles for the rights commonly associated with preference shares. Every company will have its own requirements, so the wording should be adapted as necessary.

Additional rights

Shareholders of basic preference shares do not have any right to participate in dividends or returns of capital beyond their preferential entitlement. If a company is doing well, this can result in the preference shareholders receiving less of a return than the ordinary shareholders. If the company wants preference shareholders to be able to benefit from additional dividends or returns of capital, this needs to be specifically set out. These shares are called “participating preference shares”. The model suggests wording for an equal distribution between participating preference shareholders and ordinary shareholders; this can be tailored to grant alternative rights.

Redemption

Preference shares are popular with investors, as it gives them a means of participating in the company’s profits or having their investment repaid. Where the investor’s involvement is for a finite period of time, drafting the shares as “redeemable preference shares” gives them an exit route as it enables the company to re-purchase the shares. Redeemable shares are also useful for key director shareholders, for example, as the company can redeem their shares once their involvement in management is at an end to prevent them retaining control over the company.

The key points to remember about redeemable shares are:

• there must be at least one non-redeemable share in issue
• they must be created as such, i.e. you cannot convert ordinary shares to redeemable shares
• they must be fully paid-up before redemption; and
• they need checking in the company’s articles to make sure they can be issued. Private companies can issue redeemable shares as long as their articles do not prevent them from doing so; public companies need to be specifically authorised in their articles.

The company can set out whatever conditions it needs to regarding the terms of redemption, e.g. whether it happens at the option of the company and/or the shareholder, on a particular date, in stages or conditional on certain events, etc. The model should be adapted to a company’s circumstances accordingly. It is advisable to be as specific as possible.