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Preference shares are a class of shares that give holders certain advantages or different rights over ordinary shareholders.
Most early-stage companies begin with only ordinary shares, held by founders and early employees. They tend to avoid issuing preference shares at the beginning because doing so adds legal complexity and reduces founder control.
Ordinary shares (or common shares) represent ownership in a company and typically come with voting rights. This means shareholders can vote on important matters like electing board members or approving major decisions. Dividends for ordinary shareholders are not guaranteed — they are only paid if the company chooses to distribute profits and only after preference shareholders have been paid. In the event of liquidation (if the company is shut down and its assets are sold), ordinary shareholders are the last to be paid, after all debts and preference shares. This makes ordinary shares riskier but with greater potential for reward if the company grows and its value increases.
Preference shares, in contrast, usually do not have voting rights, but they come with preferential treatment when it comes to dividends and liquidation. They often receive fixed dividends that must be paid out before any dividends go to ordinary shareholders. And if the company is liquidated, preference shareholders are repaid before ordinary shareholders.
Importantly, preference shares can be highly flexible, are often negotiated on, and customised.
Preference shares are used in a number of scenarios. Investors often accept these shares during growth financing rounds as they offer highly flexible and negotiable terms - from dividend rates and payment frequency to redemption timelines and conversion rights. Companies typically try to negotiate for lower dividend rates and optional redemption rights, while investors push for cumulative dividends, mandatory redemption dates, and anti-dilution protections.
Preference shares are also used for restructuring purposes and when dividends are distributed, for example, in family companies.
Typical drivers for considering issuing preference shares include :-
Raising capital - companies can issue preference shares to attract a specific type of investor who prioritises fixed income over capital growth.
Employee incentives - offering employees preference shares can be a retention tool and reward their loyalty.
Acquisitions and financing - preference shares can be used in complex finance structures or as part of acquisition deals.
Family Succession Planning - balancing inheritance while maintaining voting control.
Restructuring - converting debt to equity without diluting management control.
There are various types of preference shares, each with unique characteristics. The most common type is the preference share that allows for a fixed dividend, often for a set period of time (such that it can be redeemable). Other types include cumulative preference shares, which allow shareholders to receive unpaid dividends at a later date, and convertible preference shares, which provide the option to convert preferred shares into ordinary shares. Key points include :-
Participatory preference shares - holders receive a fixed annual dividend and may also benefit from additional payouts when the company surpasses certain performance benchmarks. This is perhaps the most commonly used type of preference share as it is simple to use, administer, and implement.
Redeemable preference shares - issued with a predetermined redemption period, after which the company repurchases them from shareholders based on the share value at redemption. This type of preference share is very useful as it allows for the share to be redeemed once the shareholder has received a certain amount as a dividend, thereby not interfering with the company’s shareholding structure.
Cumulative preference shares - if a dividend payment is missed, it carries forward to the next payment cycle. When dividends are eventually paid, shareholders receive both the current and any previously unpaid amounts. If dividends remain unpaid for multiple cycles, they continue accumulating until payment is made.
Non-cumulative preference shares - if the company decides to skip a dividend payment, the shareholder forfeits that payment permanently and cannot claim it in the future.
Convertible Preference shares - these shares allow holders to convert their preference shares into ordinary shares at specific intervals based on agreed terms. After conversion, shareholders gain voting rights.
Our experienced lawyers can guide you through all the options and the negotiating points which will typically arise whichever is the best type of preference shares for your situation and commercial objective.
Dilution of voting power - issuing preference shares can dilute the voting power of existing ordinary shareholders.
Dividend payments - preference dividends must be paid before ordinary dividends, impacting the amount available for distribution to ordinary shareholders.
May complicate future borrowing - preference share dividend obligations factor into lenders' assessment of the company's ability to service additional debt obligations, existing preference share agreements may contain covenants that limit additional borrowing or require preferential shareholder approval, fixed preference share dividend obligations reduce cash available for debt service.
Possible redemption issues - if preference shares are redeemable, the company needs sufficient capital reserves when redemption dates arrive.
Exit options - may create complications during company sales or exits. Drag and tag clauses and/or options may be needed to cater for a potential sale down the line.
Valuation complexity - multiple share classes can complicate company valuations
Class Rights - the specific rights and limitations attached to each class of shares need to be considered and defined, such as voting rights (full, limited, none), dividend rights (priority, fixed dividend, participation in residual profits), liquidation preferences (priority in repayment of capital), conversion rights (option to convert to another class of shares) and redemption rights (company's right to buy back the shares)
Board approval - the board of directors must approve the creation and issue of preference shares.
Shareholder and/or articles of association approval - there’s no need to amend the Articles unless they were altered at incorporation to specifically limit share classes — which is rare. Under standard Table A Articles, you can issue preference shares by passing an ordinary resolution to create and define the share class and its rights and ensuring the directors have authority to allot the shares.
Filing with Companies House - the company must file the necessary documents with Companies House to formalise the issue of preference shares.
Redemption and conversion - Some preference shares may have redemption or conversion rights, adding further layers of legal complexity.
While preference shares offer certain advantages, they also come with limitations and considerations. Depending on your specific needs and goals, several alternative options exist for raising capital or structuring ownership in a UK company:
Issuing more ordinary shares to investors or existing shareholders
Employee Stock Option Plans (ESOPs)
Debt Financing whether bank loans or overdrafts or mezzanine finance - debt with some equity features, providing more flexibility for borrowers than traditional bank loans with potential higher returns for lenders.
Joint Ventures or Strategic Partnerships - partnering with another company can provide access to resources, capital, and market reach.
Our experienced and cost effective lawyers provide expert guidance on implementing preference shares tailored to your specific needs, handling all required documentation and compliance while supporting your business objectives. our experience and services include, as necessary :-
Assessment of whether preference shares suit your company structure and objectives, short, medium and long term.
Advising on the best type of preference shares and attached rights and commercial and legal pros and cons
Articles of Association - amendments to include basic preference share rights
Shareholder Resolutions and Board Minutes - special resolutions authorising creation and issuance and documenting board approval
Family Business Succession Planning - advising on family charter amendments and integrating preference shares into succession planning and voting trust agreements if preference shares are part of voting control arrangements
For Management Incentives - drafting, reviewing or revising management rights documentation if preference shares form part of executive compensation and performance criteria documentation for performance-linked preference shares
For Corporate Restructuring - debt-to-equity conversion agreements when replacing debt with preference shares and/or creditor consent documents if restructuring involves existing creditors
Company law compliance - with Companies Act 2006 requirements
You can rely on our experience to help you understand the options, make the right choices and streamline the legal process. Please do get in contact.
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Partner - Corporate law
Nicholas is a Partner in our Corporate and Commercial team. He mainly operates out of Bedford, Peterborough, and London.
Nicholas qualified as a solicitor in 1995 with a City law firm. Since then he has gained significant experience in the City,...
