Preference share are those shares which have a preferential treatment over the other shares. They get paid first during liquidation and have a predetermined rate of dividend. Also, a firm occasionally does redemption of preference share for many reasons. The repurchase or purchase of preference shares from stakeholders is known as redemption of Preference Shares. Redemption of these shares can be done for many reasons, it includes building up the capital structure, reorganising or sometime because the company’s changing financial status. Companies shall adhere to precise process for redeeming the preference shares, regardless of the intention and motive.
Understanding Redemption of Preference Shares:-
While redeeming the preference shares, that were issued to the investors are purchased. Businesses could decide to redeem their preference share for many reasons which includes debt reduction, increased cash flow or restructuring the capital.
Preference shares can be redeemed at par or at premium such as:-
- Redemption at Par: This refers to the purchase of preference share at the original issue price. After a lock in term, which lasts for five years from date of issuance, expires, companies can redeem the shares. Preference shareholders shall get an advance notification from the corporation and this cash is mostly used to pay for the redemption amount.
- Redemption at Premium: Buying back the preference share at a price which is greater than the issue price is known as redemption at premium. Its typically done when the company’s finances are trying to get in good shape and it wants to reward the preferential shareholders. Also, as per the accordance of company act, 2013 regulations, the firm shall adhere to the specific guidelines while redeeming these shares at a premium.
Having an effect on capital structure:-
The redemption of these preference shares shows significant impact on the corporations’s capital structure. The organisations capital structure provides as to how the finance and its operations from a combination of debt and equity. Redeeming these preference shares can alter a company’s debt to equity ratios, which can have an impact on the company’s future borrowing capacity.
Further the future interest payments can be a much more if a firm redeems the preference shares by issuing more shares which would add to additional debt, impacting the cash flow.
Although the current shareholder’s ownership could be diluted if a business redeems the preference share by issue of additional preference share through equity.
Tax implications:-
The redemption of these preference shares could have tax implication for both company and shareholders. The firm would be required for paying up capital gains on the premium if it redeems its preference shares. All the capital gain taxes would also be due from the shareholders on the sale of the preference share if they have hold for an extended period of time.
Benefits and Drawbacks of Redemption:-
Redeeming these preference share has potential for increasing the value of the shareholder, lower interest costs and increase in a company’s financial flexibility.
Redeeming these preference shares, although will result in decline of the investor’s confidence, any reduction in the ownership interests of the present shareholders and a negative impact on the company’s credibility.
Advantages of Redemption of Preference Share:-
- Financial Flexibility: Redeeming these preference share could assist these businesses through releasing funds which could be utilised for different objectives which include investing in new initiatives or paying a down debt.
- Increased shareholder value: Redeeming these preference share could enhance the overall financial situation and raise shareholder value, which will help attract the new investors and support the stock price.
- Reduction in interest costs: Redeeming all these preference shares could help the corporations and company which lowers the interest cost and could result in cheaper financing cost over time.
Redeeming these preference shares could help in assisting the capital structure of firm in becoming much manageable by lowering the total number of outstanding securities.
Disadvantages of Redemption of Preference Share:-
- Increased expenses: Redemption of these preference share can incur great expense such as transaction fees, legal fees or accounting fees which could decrease the redemption’s net financial advantage.
- Redeeming preference shares could incur greater expenses such as transaction fees, legal fees, or accounting fees, which might lessen the redemption’s net financial advantage.
- Redeeming these preference shares could indicate to the credit rating agencies that the company is facing financial problems which could result in lower credit rating and increased borrowing cost.
- Reducing the company’s flexibility: Such Redemption can limit the company’s ability for getting engaged in future capital raising action such as issuing new securities or getting new debt.
- Reduced liquidity: When there are few securities available for trade due to redemption of preference shares, it can become more challenging for the investors for acquiring or selling the shares.
- When there are not so many securities available for trading cause of redemption of preference share it can become much challenging for the investors for acquiring or selling shares.
Preference Share Redemption Process
The steps in the preference share redemption process are as follows:
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Reviewing Memorandum of Association (MOA) and Articles of Association (AOA):-
A corporations shall analyse its AOA and MOA before deciding to redeem its preference share for making sure that its permitted for doing so. The AOA and MOA also provides the terms and circumstances for redeeming these preference shares.
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Permission of the board of directors:-
The company can request the board permission for determining that AOA and MOA permit the redemption of the preference shares. The boards shall approve a resolution which permits the redemption of the preference share of the directors.
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Get shareholder approval
The corporations shall receive permission from board of directors before seeking a shareholders approval. The corporation should conduct a general shareholder meeting and adopt a particular resolution before redeeming the preference shares.
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Stock Market information
The firm shall inform the Exchange of the plan for redeeming the preference shares if the stock is listed in the stock exchange. The company shall disclose the number of shares which are to be redeemed, the redemption price and date of redemption.
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Redemption Reserve Account Creation
If the company is redeeming the preferential shares at premium, it shall construct a Redemption Reserve Account. It shall use the profits for transferring the required sum in the account. After this redemption of preference shares, the Redemption Reserve Account shall be kept open for minimum two years.
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Amount paid to shareholders
After the completion of above mentioned, the corporation shall pay the owners for the redeemable preference share. This payment is required to be made in the time frame which is included in the AOA and MOA or according to the Companies Act, 2013.
Reasons for redemption of preference share
Increasing the value of shareholder, lowering the interest cost, increasing this financial flexibility for business and streamlining this capital structure are some possible solutions.
Normative and legal requirements
Companies must abide by a number of legal and regulatory criteria when redeeming preference shares. Some of these obligations, including getting shareholder permission, according to SEBI regulations.
Conclusion
In conclusion the company can benefit from the redemption of preference shares in many ways. They could be able in lowering the debit and enhancing the cash flow. They could be able to issue more of preference shares or equity shares in future cause of the flexibility it provides in the capital structure. Also the investors will be affected by this redemption procedure. Preference shareholders put risk which involves their precedence in receiving payments during the liquidations as well as the regular dividend payments.
Business shall make sure that the redemption of preference shares is allowed in the Article of Association (AOA) and Memorandum of Association(AOA). Companies should also authorise for redemption of the preference shares by a particular special resolution at general meeting of the firm.
Issue and redemption of preference shares by company in infrastructural projects.- A company engaged in the setting up and dealing with of infrastructural projects may issue preference shares for a period exceeding twenty years but not exceeding thirty years, subject to the redemption of a minimum ten percent of such preference shares per year from the twenty first year onwards or earlier, on proportionate basis, at the option of the preference shareholders.
