What is Redemption of Preference Shares
Redemption of Preference Shares refers to the process by which a company buys back its preference shares from the shareholders at a predetermined price and date. This allows the company to reduce its capital and improve its financial position. Preference shares are a type of shares that give shareholders the right to receive a fixed dividend before any dividends are paid to ordinary shareholders. In this article, we will discuss the redemption of preference shares in detail.
Types of Redemption
There are two types of redemption of preference shares:
- Mandatory Redemption: In this type, the company is bound by the terms of the issue to redeem the preference shares after a certain period. The redemption is done at the discretion of the company.
- Optional Redemption: In this type, the company has the option to redeem the preference shares at any time after a certain period. The redemption is done at the discretion of the company.
Reasons for Redemption
Companies redeem preference shares for various reasons, such as:
- Reduce Debt: By redeeming preference shares, companies can reduce their debt and improve their financial stability.
- Improve Capital Structure: Redemption of preference shares helps in maintaining an optimal capital structure by reducing the cost of capital.
- Enhance Shareholder Value: Redemption of preference shares can enhance shareholder value by increasing earnings per share.
- Compliance: Companies may redeem preference shares to comply with regulatory requirements or to simplify their capital structure.
Procedure for Redemption
The procedure for the redemption of preference shares involves the following steps:
- Approval: The redemption must be approved by the board of directors and shareholders of the company.
- Payment: The company must set aside funds for the redemption and make the payment to the shareholders on the redemption date.
- Cancellation: The redeemed shares are cancelled, and the company’s capital is reduced accordingly.
Example of Redemption
ABC Ltd issued 1,000 preference shares at a face value of $10 each with a fixed dividend of 5%. After 5 years, the company decides to redeem 500 preference shares at $12 each. The total redemption amount would be $6,000 ($12 x 500 shares).
Case Study
In 2020, XYZ Corp redeemed its preference shares worth $1 million to improve its capital structure and reduce its debt. As a result, the company’s financial position strengthened, and its credit rating improved, leading to lower borrowing costs.
Conclusion
Redemption of preference shares is a strategic financial decision that can benefit companies in various ways. By understanding the process and implications of redemption, companies can effectively manage their capital structure and enhance shareholder value.
