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 the predetermined price mentioned in the prospectus at the time of issuance of preference shares. 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 type of preference sharesType Of Preference SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation. issued to shareholders with a callable option embedded, meaning they can be redeemed later by the company.
- It is one of the methods companies embrace to return cash to the existing shareholders of the company. It is a way of share repurchasing but is different from traditional share repurchases in certain ways.
- The prices at which companies can repurchase these redeemable shares are already decided during issuing those shares.
- Issuing callable preference shares that can be redeemed in the future provides the company flexibility to choose whether to go for share repurchase or share redemption.
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Simple Example of Redeemable Preference Shares
Let us assume an arbitrary example to see how the shares are redeemed by a company A. Let’s assume that the company used the redeemable preference shares and 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 preference shares when the price of the company is lesser than the call price. And the company can go for share repurchases instead of redeeming the shares. If they cannot secure a share repurchase, they can always fall back on the option of redeeming the shares. That way, the company has greater flexibility if it has issued redeemable shares.
If any, the redeemable preference shares 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 is reported by the company.
In the example depicted here, two sets of redeemable preference shares exist. One of them is 4000 in the count of shares.
- The coupon rate paid by the company for these redeemable preference shares is 10%.
- For the other, the share count is 2000. The coupon rate paid by the company for these 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 preference shares allows the company to choose whether to repurchase 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 dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.. When the companies redeem shares, the number of total shares outstanding reduces for the company, and the earnings per share or the company’s EPSEPS 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 an increase in the share price.
- By redeeming shares, the company, most of the time, gets 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 company’s existing shareholders.
- Redeemable preference shares often provide exit opportunities for venture capitalVenture CapitalVenture capital (VC) refers to a type of long-term finance extended to startups with high-growth potential to help them succeed exponentially. 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. 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 until the time after which it can exercise the option of redeeming its shares. The company also needs to wait for the current market price to be favorable 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.
- Suppose a company has issued redeemable preference shares. In that case, 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. As a result, 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 company’s EPS increases. This increases the value of the company. When a company has issued redeemable preference shares, it allows the company 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 with simple and practical examples, advantages, disadvantages & limitations. You may learn more about finance from the following articles –