Redeemable preference shares are those shares where the issuer of the share has the right to redeem the shares within 20 years of the issuance at pre-determined price mentioned in the prospectus at the time of issuance of preference shares and before redeeming such shares the issuer shall assure that redeemable preference shares are paid up in full and all the conditions specified at the time of issuance are fulfilled.
What are Redeemable Preference Shares?
Redeemable Preferences shares are those type of preference shares issued to shareholders which have a callable option embedded, meaning they can be redeemed later by the company.
- It is one of the methods that companies embrace in order to return cash to the existing shareholders of the company. It is a way of share repurchase but is different from traditional share repurchases in certain ways.
- The prices at which companies can repurchase these redeemable shares are already decided during the time of issuing those shares.
- Issuing callable preferential shares that can be redeemed in the future provides the company flexibility to choose from whether to go for share repurchase or go for shares redemption.
Simple Example of Redeemable Preference Shares
Let us assume an arbitrary example in order to see how the shares are redeemed by a company A. Let’s assume that the company while using the redeemable preferential shares, had a call option for those shares at $180 at the predetermined time frame. Suppose the shares are trading at the market price of more than the callable price. Here the company can call the redeemable preferential shares when the price of the company is lesser than the call price. And the company can go for share repurchase instead of redeeming the shares. If they are not able to secure a share repurchase, they can always fall back for the option of redeeming the shares. That way, the company has greater flexibility if it has issued redeemable shares.
The redeemable preferential shares, if any, are reported by the company in its balance sheet in the shareholder’s equity section. Below is the snapshot of the shareholder’s section of the balance sheet where the information of redeemable preference shares reported by the company.
In the example depicted here, there are two sets of redeemable preference shares. One of them is 4000 in the count of shares.
- The coupon rate paid by the company for this redeemable preference shares is 10%.
- For the other, the share count is 2000. The coupon rate paid by the company for this redeemable preference shares is 9%.
|Share Capital||Cash and Bank Balances||2,00,000|
|5,000 equity shares of Rs 100 fully paid||5,00,000||Other Assets||9,00,000|
|4,000 10% redeemable preference shares of 50 each, Rs 25 per share paid||1,00,000|
|2,000 9% redeemable preference shares of Rs 100 fully paid||2,00,000|
|Reserves and Surplus|
|Security Premium A/c||10,000|
|Capital Redemption Reserve A/c||1,00,000|
|Dividend Equalisation Fund||1,10,000|
Advantages of Redeemable Preference Shares
The advantages of redeemable preference shares are as follows-
- Issuing redeemable preferential shares provides the company with an option to choose between whether to repurchase shares or redeem shares depending on the market condition.
- The company redeems shares when it decides to pay back the shareholders. It is a way of paying the shareholders similar to paying dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.. When shares are redeemed by the companies, the number of total shares outstanding reduces for the company, and the earning per share or the EPS of the companyEPS Of The CompanyEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is. increases, which leads to the increase in the share price.
- By redeeming shares, the company, most of the time, get rid of shares that were paying coupon rates, which are much higher than the current dividend yield for the equity shareDividend Yield For The Equity ShareDividend yield ratio is the ratio of a company's current dividend to its current share price. It represents the potential return on investment for a given stock.—thus increasing the value for the existing shareholders of the company.
- Redeemable preferential shares often provide exit opportunities for venture capital funds, which are provided with a predetermined exit option at a predetermined time and predetermined price point.
Disadvantages of Redeemable Preference Shares
The disadvantages of redeemable preference shares are as follows-
- These kinds of shares are feasible for the companies to redeem only when the call price of the shares is lower than the current market price of the shares. Otherwise, it’s logical for the company to go for share repurchases instead.
- The company needs to wait for the time predetermined while issuing the shares before being able to redeem the shares.
Limitations of Redeemable Preference Shares
The limitations of redeemable preference shares are as follows-
- The company can only redeem shares if it has issued redeemable shares earlier. Otherwise, the company does not have the option to redeem its shares.
- The company needs to wait to the time after which it can exercise the option of redeeming the shares of the company. The company also needs to wait for the current market price to be favorable for it to redeem the shares.
Important Points to Note
Important points regarding Redemption of Preference Shares-
- The company can only redeem shares if it has issued redeemable preference shares. Otherwise, the company does not have the option to redeem its shares.
- If a company has issued redeemable preference shares, then it provides the company with an option to choose between whether to repurchase shares or redeem shares depending on the market condition.
It is a way of paying the existing shareholders, very similar to paying dividends to the shareholders. By redeeming preference shares, the company gets rid of higher-paying coupon rate securities; in a way, increasing the shareholder’s value by redeeming preference shares. The number of total outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet. decreases, and the EPS of the company increases. This increases the value of the company. When a company has issued redeemable preferential shares, it provides the company with an option to choose between whether to repurchase shares or redeem shares.
This has been a guide to Redeemable Preference Shares and its definition. Here we discuss Redeemable Preference Shares simple and practical examples along with its advantages, disadvantages & limitations. You may learn more about finance from the following articles –