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Types of Preference Shares (Preferred Stock) - Explained in Hindi | #9 Master Investor - YouTube
Channel: Asset Yogi
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Namaskar, my name is Mukul and welcome to Asset Yogi.
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Friends in the last video we got to know the difference
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between common equity shares and preference shares
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If you haven't watched that video,
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watch that before watching this video
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So that you can understand it properly.
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You will get the link below in the description.
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In that video, we saw that common equity shares holders
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mainly get returns in the form of share growth.
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The company sometimes declares dividends, sometimes not.
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And mostly very few dividends are declared,
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if we talk in comparison to share price movement.
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On the other side, preference shareholders are given
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fixed returns in the form of dividends.
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The company says take these returns of 12-14%.
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These are always fixed,
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Whether share price goes up or down,
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or profit goes up or down.
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You'll always get these returns.
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So mainly it works like bonds.
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But now the question arises that if returns are fixed,
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is there only one type of preference share?
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Are there any standard terms and conditions?
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Of course not. Terms and conditions can depend.
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There are various types of preference shares.
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Like callable preference shares, convertible, perpetual,
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fixed maturity date preference shares.
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So how many types of preference shares are there?
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What things you should consider if you're investing in preference shares?
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We'll discuss all these things in this video.
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So watch this video till the end.
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Let's go straight to the blackboard.
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If a company issues preference shares
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then how will we know what kind of preference share is this?
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For this, you have to read the share certificate. Whichever share
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certificate is issued to you, it will have terms and conditions
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For example, the first condition you have to look for is
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that how much dividend is being promised to you?
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So if a 14% dividend is being promised
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then what kind of dividend is that?
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Are these cumulative or non-cumulative preference shares?
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So firstly let's talk about cumulative and non-cumulative.
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Let's say the maturity period for preference shares is 10 years,
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and the company says you'll get 14% dividends each year.
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Let's say in the first year company easily gives 14% dividends.
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Business is good and it easily gives in the second year too.
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In the third year let's say business is not good and the company is at loss,
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and it can't pay your dividends.
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So if in the fourth year business is again good,
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then they definitely have to give 14% dividends of 4th year,
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Plus they have to give 14% of the third year as well.
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And let's assume business wasn't good in the fourth year also,
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They couldn't pay these dividends.
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Then in this case, in the fifth year, they have to give 14%, 14%,
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and 14%, so totally they have to pay
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3rd, 4th, and 5th year dividends together.
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That's what we call cumulative dividends or cumulative preference shares.
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So whatever dividends you have, in years company couldn't pay dividends,
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all of it adds up and becomes its liability.
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On the other side, there are non-cumulative preference shares,
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and let's say the maturity period is of 10 years.
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Let's take the same example.
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In the first two years company easily gives 14%-14% dividends
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IF it can't pay in the third year,
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Then in the fourth year, its liability is only 14%.
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In previous years if it could not pay dividends,
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The company has no liability for that. Those won't add.
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Assume the business is not good and they can't pay,
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then they won't pay. That's it.
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If in sixth-year business is good again, then they'll pay 14%.
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So it's not like if they couldn't pay dividends in a year,
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then it becomes their liability.
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That's why we should be careful of what's written in terms and conditions.
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Let's look at other types of preference shares.
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One is the convertible preference shares.
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What do they mean?
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If it's written in your share certificate, that
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it is convertible after 5 years, that means
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company can convert them into ordinary shares after 5 years.
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We've already seen the meaning of ordinary and preference
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shares in our previous video.
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If you haven't watched that video, please watch it.
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In which we have talked about preference and equity shares.
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So what's different in ordinary shares?
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The first thing is the fixed dividend you were getting here,
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you won't get that.
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Any dividends declared by the company for common shares,
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you might get those.
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But the main profit of these is that,
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ordinary shares get growth in the share price,
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which preference shares don't get.
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So after 5 years if it converts in an ordinary share,
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then it'll get share price growth mainly,
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It won't get these fixed dividends.
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And if it's a non-convertible preference share,
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that means it can't be converted.
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It'll be only a preference share for its maturity period.
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Let's see other types of preference shares.
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One type is redeemable preference shares.
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What does redeemable mean?
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It's clearly written that it'll be redeemable after 5 years.
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That means their maturity date is of 5 years.
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After 5 years whatever their issue price was,
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company will buy them at that price.
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Let's say the issue price was 100 rupees per share.
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So after 5 years, you'll get the shares at 100 rupees per share.
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So that's the maturity date.
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While the non-redeemable shares don't have any maturity date.
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Till the company is there.
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Let's say the company raised some capital at 100 per share.
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But you'll never get that money back.
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What will you get back? you'll get 14% dividends per year.
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Means whatever dividends are promised to you.
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So non-redeemable
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preference shares are also called irredeemable,
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or perpetual preference shares also.
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Now focus here a bit,
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In India, non-redeemable preference shares are not allowed.
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As per company act 2013
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All preference shares must be redeemed within 20 years.
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So the maturity date should be less than 20 years.
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Besides these, there is callable preference share.
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Don't get confused about callable and redeemable,
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What does callable mean?
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That the company has a call option,
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that after a certain time period, the company
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can buy back those shares.
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Redeemable means it's the maturity date.
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The maturity date could be 10 years,
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and after 5 years company says we have the call option
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Let's say we issued the share at 100 rupees per share.
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but after 5 years we'll buy shares from you at 150 RS per share.
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The company can buy back those shares,
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at a pre-defined date and pre-defined price.
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So in a way callable means,
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the company can call back those shares from you.
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Other than this you get to see adjustable rate preference shares in the market.
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Generally, the dividend of 14% is fixed here,
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but the company does not want to take interest rate risk.
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It does not fix this interest rate,
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It links the interest rate. For example,
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SBI says they'll give 5% on their MCLR rate.
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So the dividend is linked to a rupee interest benchmark rate.
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It can be SBI mclr rate or any other rate,
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for example, it can be the repo rate of RBI.
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IT depends on how the company wants to issue it.
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Why does company do it?
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We already talked that the company wants to reduce risk of interest rate risk.
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The company doesn't want to always give 14%, it's possible
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that after 3 years what's the market interest rate.
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we can get money at 10% , why should we give 14% to someone?
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And I gave you an example of this.
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It can say whatever the SBI mclr rate is,
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The company will give 5% or 3% on that mclr rate.
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If we talk about internationally, London interbank offer rate
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is used generally as a benchmark date.
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Plus the company can give x percent on top of that.
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Now those were callable and adjustable preference shares.
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Now let's see what are participation preference shares.
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So participation preference shares mean,
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that you get some additional benefits.
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What are these additional benefits?
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Participation means that these shares are
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participating in the benefits of some common shares.
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If it's a participating preference share then it gets some benefits of common shares.
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Now, what are these benefits?
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Generally, there are two benefits,
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One is that it can get additional dividends.
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They will definitely get 14% fixed dividends here,
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but assume the company gave more than 14% dividends to common shares.
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Let's say the company said
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The preference shares will get 10Rs per share dividends,
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While the company gave 12 Rs per share dividend
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to common shares in one year.
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So this difference of 2 Rs,
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The company will have to give 12 Rs per share to preference shares,
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if it's written that these are participating preference shares,
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and the dividends for common shares is more,
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so whatever the difference is,
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the company will have to give preference shares that.
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So if dividends for common shares get more than
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a certain amount, then the company has to pay the difference.
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Second,
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if there is any liquidation event, the company is getting sold,
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so in this case all the preference shares will get initial capital,
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plus common shareholders are getting whatever money
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on the pro-rata basis, preference shares will get that as well.
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Let's understand it also from an example.
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Let's assume when the company initially raised the money,
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So the total share capital was let's say 10 crores,
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and in that, the preference shares were of 2 crores.
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2 crores mean 20% capital was of preference shares,
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and if we talk about common shares then it was 8 crores.
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Now assume that after some this company
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is sold for 15 crores.
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So the total share capital of the company is 15 crores here.
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So in this case who will get how much money?
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If there is participating share, how much will it get in that case
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and how much will get in case of a non-participating share?
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Let's see that.
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So initial capital for preference share was 2 crores,
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so it's always a safe capital.
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SO preference participating shares will get 2 crores,
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plus
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their capital was 20%.
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So we'll minus these 2 crores from 15 crores.
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So what's the remaining balance?
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13 crores remaining.
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Now 20% of these 13 crores,
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that will be given additionally. what's 20% of 13 crores?
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2.6 crores.
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So in this case participating preference shares will get a total of 4.6 crores.
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But if there is any non-participating preference share,
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then it'll get only, I'll write it down here.
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non-participating will get only 2 crores.
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cause preference share capital is always a safe capital.
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It works like a bond.
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Preference shares only deal with their dividends,
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they don't deal with the company's growth that much.
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But if there is any participating preference share,
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that means it wants to participate in the growth of the company.
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right?
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So if there is a liquidation event, the company is sold at a higher price,
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then preference shares get profit in that case.
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And we also saw the benefits of dividends,
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that if common shares get more dividends, then whatever the
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difference is, preference shares will get that as well.
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So I think after watching the video, you now have an idea
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about the types of preference shares.
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And whenever you read a document of preference share,
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then read the terms and conditions carefully.
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So you understand properly what you're being promised.
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If you liked this video, like and share the video.
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If you have any suggestions or you want to suggest topics for future videos,
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or you want to share some thoughts with the community,
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you can comment down below.
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And to get the latest finance and investing tips,
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subscribe to this channel.
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Let's meet in the next video.
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Till then keep learning, keep earning, and as always be happy.
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