Preference Shares vs. Bonds: An Overview
Although holders of preference shares and bonds are both entitled to regular distribution payments, preference shares do not have a maturity date and can continue in perpetuity. Bondholders are entitled to the receipt of regular interest rate payments, while holders of preference shares receive regular dividend payments.
Key Takeaways
- A bond is a fixed income instrument that represents a loan made by an investor to a borrower.
- Preference shares are shares of a company’s stock with dividends that are paid out.
- Bonds often have a maturity date, while preference shares do not.
- Bondholders have a higher chance of being paid in bankruptcy versus holders of preference shares.
Bonds
A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). Bondholders are creditors of the company, having loaned it money.
A bond has an end date when the principal of the loan is due to be paid to the bond owner and usually includes the terms for variable or fixed interest payments that will be made by the borrower.
Bonds have a fixed maturity and ultimately expire, limiting the amount of interest paid out.
Bondholders, as creditors of the company, have a higher chance of being paid versus holders of preference shares, depending on the priority of the debt. Bonds may be secured by assets of the company. The principal can be paid back to the bondholder by the sale of those assets in case of a bankruptcy. Unsecured bonds are not backed by any assets of the company and have a lower likelihood of receiving any distributions.
Most bonds can be sold by the initial bondholder to other investors after they have been issued. In other words, a bond investor does not have to hold a bond all the way through to its maturity date.
Preference Shares
Holders of preference shares own a piece of the company. Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, preferred stockholders are entitled to be paid from company assets before common stockholders.
Most preference shares have a fixed dividend, while common stocks generally do not. Preferred stock shareholders also typically do not hold any voting rights, but common shareholders usually do. Unlike bond payments, which are mandatory, holders of preference shares may miss some dividend payments if the company does not make a profit. If the preference shares are cumulative, the investor is entitled to receive payment for missed dividends prior to any dividends being paid to common shareholders.
Preference shares continue as long as the company is in business, or, for redeemable stock, until the company decides to buy it back.
In the case of bankruptcy or dissolution, holders of preference shares have a higher priority over common shareholders in being paid off when the company’s assets are liquidated. As a practical matter, preference shareholders are unlikely to receive any money during a bankruptcy dissolution, as they are fairly low on the priority list for repayment.
Preference shares fall under four categories: cumulative preferred stock, non-cumulative preferred stock, participating preferred stock, and convertible preferred stock.
Preference shares do not come with voting rights.
Key Differences
The main difference between preference shares and bonds is that shares represent ownership of the company, while bonds simply represent a loan obligation. If the company is dissolved, bondholders are among the first in line to get a payout of the remaining assets. Preferred shareholders are further back in line, and less likely to recoup their full investment.
There are also structural differences. A typical bond pays out a fixed coupon at regular intervals, until the maturity date when the entire principal is returned to the investor. A preferred share has no maturity date: It continues paying dividends for the lifetime of the company
What Is the Difference Between Preferred Stock and Common Stock?
Preferred shares are a type of ownership share that receives a higher dividend than common stock, although they do not confer voting rights. In the event that the company dissolves, preferred shareholders have preference over common shareholders, meaning that they are more likely to recoup part of their investment.
What Are the Downsides to Preferred Stock?
Preferred shares tend to have lower liquidity than common shares, meaning that they are harder to sell at market price. In addition, they do not confer voting rights.
How Do You Convert Preferred Stock?
Some preferred shares are convertible, meaning that they can be exchanged for common shares at a fixed price and ratio. The exact terms for conversion will be spelled out in the issuance documents for the preferred stock. If the company is successful, investors can benefit from exchanging the stability of their preferred shares for the higher gains of the common shares.
The Bottom Line
Preferred stock is a type of ownership share that comes with a fixed dividend, giving it some similarities to a bond. However, bondholders have a higher priority for repayment if the company dissolves. Preferred shareholders receive a higher dividend than owners of common stock, although they do not have voting rights.