Issue and redemption of preference shares and debentures are important activities for companies to raise long-term funds. Preference shares and debentures are popular investment options for investors, as they offer a fixed rate of return and are relatively less risky than equity shares. In this section, we will discuss the process of issuing and redeeming preference shares and debentures.
Issue of Preference Shares:
Preference shares are a type of equity shares that provide a fixed rate of return to the investors, usually in the form of dividends. The process of issuing preference shares involves the following steps:
- Determine the amount of funds to be raised: The first step in issuing preference shares is to determine the amount of funds to be raised. This involves assessing the company’s capital requirements and deciding on the appropriate amount of preference shares to be issued.
- Decide on the terms of the issue: The terms of the issue need to be decided, including the dividend rate, the redemption period, and the rights of preference shareholders. These terms are usually set out in a prospectus or offer document.
- Obtain regulatory approvals: Companies need to obtain regulatory approvals from the Securities and Exchange Board of India (SEBI) and other relevant authorities before issuing preference shares.
- Issue the shares: Once all approvals are obtained, the company can issue the preference shares to investors through a public or private placement. The company needs to ensure that it complies with all regulatory requirements during the issuance process.
Pros of issuing preference shares:
- No dilution of ownership: Unlike equity shares, preference shares do not dilute the ownership of the existing shareholders as they do not carry voting rights.
- Fixed dividend payout: Preference shareholders are entitled to receive a fixed dividend payout, which is generally higher than the dividend paid on equity shares. This makes preference shares an attractive investment option for investors seeking a regular income stream.
- Priority in asset distribution: In case of liquidation, preference shareholders have priority over equity shareholders in the distribution of assets. This means that they are more likely to receive their investment back in case of a company’s liquidation.
- Flexibility in redemption: Preference shares can be redeemed at a fixed or variable price, giving companies greater flexibility in managing their capital structure.
Cons of issuing preference shares:
- Higher cost of capital: The fixed dividend payout on preference shares increases the cost of capital for the company, which can negatively impact profitability.
- Limited upside potential: Preference shareholders do not participate in the company’s growth or share in its profits beyond the fixed dividend payout.
- Limited marketability: Preference shares are less marketable than equity shares, which can make it difficult for investors to sell them in the secondary market.
Redemption of preference shares:
Redemption of preference shares refers to the process of buying back preference shares from investors. The process of redeeming preference shares involves the following steps:
- Check the terms of the issue: The terms of the issue need to be checked to determine the redemption date and the redemption price. The redemption price is usually the face value of the shares plus any premium or dividend arrears.
- Give notice to shareholders: The company needs to give notice to the preference shareholders of the redemption date and the redemption price.
- Make arrangements for payment: The company needs to make arrangements to pay the redemption price to the shareholders on the redemption date. This may involve setting up a sinking fund or using internal accruals.
- Redeem the shares: On the redemption date, the company needs to redeem the preference shares by paying the redemption price to the shareholders.
Redemption of preference shares involves repurchasing them from shareholders at a pre-determined price. Companies may redeem preference shares for a number of reasons, such as reducing their debt burden, improving their credit rating, or increasing their financial flexibility.
Pros of redeeming preference shares:
- Lower cost of capital: Redeeming preference shares can help companies reduce their cost of capital, as they no longer have to pay a fixed dividend to preference shareholders.
- Improved credit rating: Redeeming preference shares can improve a company’s credit rating, making it easier for them to raise capital in the future.
- Greater financial flexibility: Redeeming preference shares can improve a company’s financial flexibility, as it frees up cash that can be used for other purposes such as investing in growth opportunities or paying down debt.
Cons of redeeming preference shares:
- Cash outflow: Redeeming preference shares requires a cash outflow, which can negatively impact a company’s liquidity position.
- Loss of investor confidence: Redeeming preference shares may lead to a loss of investor confidence, as it may be viewed as a sign of financial weakness or instability.