Other Types of Preferred Shares
New products are constantly being introduced to the marketplace, many of which are custom-made for the issuer or the buyer. Many of these less common types of preferred shares, including participating preferred shares and deferred preferred shares, typically trade with institutional buyers. As an advisor, you must always investigate such securities to confirm the features of a particular issue before recommending them to your clients.
Participating Preferred Shares
Participating preferred shares provide certain rights to shareholders, allowing them to share in the earnings of the company over and above their specified dividend rate.
Example
STU Inc. Non-cumulative Participating Voting Preferred Shares - These shares participate equally with subordinate voting shares in any further dividends after $0.009375 per share has been paid on the subordinate voting shares. Additionally, shareholders can participate in any distribution of assets.
Deferred Preferred Shares
Deferred preferred shares do not pay out a regular dividend; instead, they mature at a preset future date. On the maturity date, the difference between the purchase price and the redemption value is referred to as the dividend premium. This premium represents the cumulative amount that would have been paid as dividends over the holding period. Notably, the dividend premium is not eligible for the dividend tax credit.
Advantages:
- Tax Deferral: Investors can defer taxes paid on income until a later date.
- Compounded Growth: Shares are attractive for investors desiring compounded growth in a registered account.
Common Questions (FAQs)
Why do companies issue preferred shares instead of common shares or fixed-income securities?
Companies may issue preferred shares as they provide flexible financing options, and dividends can often be skipped without leading to default – an advantage over bonds.
What are the key features and unique benefits of various types of preferred shares from the perspectives of the issuer and the investor?
From the issuer’s perspective, preferred shares can be an appealing alternative for raising capital without diluting voting rights, as typically preferred shares do not have voting rights. Moreover, they have less stringent repayment obligations compared to bonds.
From the investor’s perspective, preferred shares can offer higher dividend yields compared to common shares and may have preferential claim on assets upon liquidation.
Key Takeaways
- Participating Preferred Shares: Offer investors a share in the profitable earnings of the company over a specified dividend rate and the right to participate in asset distribution.
- Deferred Preferred Shares: Attractive for tax deferment and compounded growth, typically used by investors seeking to defer income.
Glossary
- Dividend Premium: The cumulative amount of dividends that would have been paid out over the holding period, applicable to deferred preferred shares, realized upon maturity.
- Tax Deferral: A deferment of tax payments to a later date, often used strategically in investment planning.
- Non-cumulative Shares: Shares where unpaid dividends do not accumulate; if dividends are missed, they are not payable in the future.
Chart and Diagram
Here’s a simple flow chart outlining the differentiation between participating and deferred preferred shares:
graph TD
A[Preferred Shares] --> B[Participating Preferred Shares]
A --> C[Deferred Preferred Shares]
B --> D[Rights to Share in Profits]
B --> E[Participate in Asset Distribution]
C --> F[Deferred Dividends]
C --> G[Tax Deferral]
F --> H[Growth Until Maturity]
Canadian Securities Course | Volume 1
📚✨ Quiz Time! ✨📚
## What defines participating preferred shares?
- [ ] Shares that pay dividends only upon liquidation of the company
- [x] Shares that have certain rights to share in the earnings of the company over and above the specified dividend rate
- [ ] Shares that do not participate in any distribution of assets
- [ ] Shares that are always non-voting
> **Explanation:** Participating preferred shares have rights to share in the company's earnings over and above their specified dividend rate and can also participate in any distribution of assets.
## What is the key characteristic of deferred preferred shares?
- [ ] They pay regular monthly dividends
- [ ] Their dividends are tax-exempt
- [x] They do not pay out a regular dividend and mature at a preset future date
- [ ] They provide immediate tax benefits
> **Explanation:** Deferred preferred shares do not pay regular dividends but instead mature at a future date, at which point the difference between the purchase price and redemption value is the dividend premium.
## What is the dividend premium in deferred preferred shares?
- [ ] The total amount of regular dividends paid to date
- [ ] The initial purchase price of the shares
- [ ] The market price of the shares at the time of purchase
- [x] The cumulative amount equal to the dividends that would have been paid, realized at maturity
> **Explanation:** The dividend premium is the cumulative amount equal to the dividends that would have been paid, realized at the maturity of the deferred preferred shares.
## What is an advantage of deferred preferred shares for investors?
- [ ] Immediate access to tax credit
- [x] Deferral of taxes paid on income until a later date
- [ ] Guaranteed monthly income
- [ ] Exempt from market fluctuations
> **Explanation:** Deferred preferred shares allow investors to defer taxes on income until a later date, making them attractive for long-term investment and tax planning.
## How do participating preferred shares benefit the shareholders in terms of asset distribution?
- [x] They can participate in any distribution of assets
- [ ] They receive no part of asset distribution
- [ ] They receive a fixed percentage of asset distribution
- [ ] They are subordinate to common shareholders in receiving assets
> **Explanation:** Participating preferred shareholders can participate equally with subordinate voting shares in any further distribution of assets.
## Why might an issuer choose to release deferred preferred shares rather than regular dividend-paying shares?
- [ ] To guarantee regular income to investors
- [x] To attract investors looking for compounded growth and tax deferral benefits
- [ ] To avoid paying any dividends
- [ ] To provide immediate tax benefits to investors
> **Explanation:** Issuers release deferred preferred shares to attract investors seeking compounded growth over time and benefits of tax deferral.
## Which of the following is NOT a feature of participating preferred shares?
- [ ] Rights to share in earnings over a specified dividend rate
- [ ] Participation in any asset distribution
- [x] Guaranteed regular monthly dividends
- [ ] Equal participation with subordinate voting shares in further dividends
> **Explanation:** Participating preferred shares do not guarantee regular monthly dividends but rather grant rights to share in company earnings over the specified rate and participate in asset distribution.
## For an investor, what is a potential benefit of holding deferred preferred shares in a registered account?
- [ ] Immediate payment of dividends
- [ ] Monthly income streams
- [x] Compounded growth and potential tax benefits
- [ ] Guaranteed capital appreciation
> **Explanation:** Holding deferred preferred shares in a registered account can offer compounded growth and potential tax benefits, as taxes on dividends are deferred.
## Why must an advisor thoroughly investigate less common types of preferred shares before recommending them?
- [ ] To ensure liquidity in the open market
- [ ] To establish the lowest purchase price
- [x] To confirm the specific features and benefits of the particular issue
- [ ] To comply with international trading regulations
> **Explanation:** It is crucial for an advisor to thoroughly investigate the specific features and benefits of less common preferred shares to make appropriate recommendations to clients.
## What tax benefit is NOT available to holders of deferred preferred shares?
- [x] Dividend tax credit
- [ ] Tax deferral until maturity
- [ ] Reduced taxes on dividend premiums
- [ ] Tax benefits in a registered account
> **Explanation:** The dividend premium paid on deferred preferred shares is not eligible for the dividend tax credit, although other tax benefits like deferral and registration benefits are available.