Preferred Stock: Benefits, Risks & Uses in the UK

Thinking about raising capital for your business, or perhaps you’re a potential investor curious about how different share types work in the UK? The world of company shares can seem a little overwhelming – but don’t stress. Whether you’re building your first venture or navigating a growing company, understanding the options for preferred stock (often called “preference shares” in the UK) is a powerful way to strengthen your legal and financial foundations from day one.

In this guide, we’ll break down exactly what preferred stock is, how it stacks up against ordinary and other share types, and the real pros and cons you’ll want to know – all in plain English. We’ll also look at how preferred shares can be tailored for your specific needs and why they’re used by UK startups and established companies alike.

Let’s demystify preferred stock so you can make the best decision for your business or investment journey. Ready? Keep reading to get the full picture.

What Is Preferred Stock in the UK?

Preferred stock-more commonly referred to as “preference shares” in England-is a special class of share that gives its holders certain advantages over standard ordinary shares. The most notable benefit? Preference shareholders have “first dibs” on dividends: they’re entitled to receive their dividend payments before any are paid out to ordinary shareholders.

Here are some key features of preferred shares in the UK:

• Priority dividends: Preference shareholders get paid their dividends before ordinary shareholders receive anything.
• Typically fixed income: The dividend is usually set at a fixed rate (for instance, 5% per annum), making it a potentially more predictable revenue stream.
• Higher ranking on company assets: If the company gets liquidated, preferred shareholders stand ahead of ordinary shareholders in line for pay-outs. However, creditors and bondholders still come first.
• Voting rights: Preference shares generally do not come with voting rights, meaning these shareholders have limited say over company decisions, unlike ordinary shareholders.

You might see these shares described as “preferred stock” in US sources, but in England, the legal and practical treatment is much the same. The specifics are always set out in your company’s documents and articles of association.

What Are the Main Types of Shares? (Ordinary vs Preferred vs Redeemable)

When setting up or investing in a company, it helps to know how preferred shares fit into the bigger picture of share types. Here’s how each major category compares:

Ordinary Shares

• The most common type issued to founders and investors in UK businesses.
• Carry voting rights-so holders have a direct say in important company decisions, including who’s on the board.
• Dividends can vary and are not guaranteed. If there’s no profit, there’s no payout.
• Rank last in receiving assets if the company is wound up.

Preferred (Preference) Shares

• Dividends are paid first, and often at a fixed rate.
• Generally no or limited voting rights.
• Rank above ordinary shareholders in liquidation (but below creditors).
• Can be tailored with extra features-more on this below.

Redeemable Shares

• A company can buy these shares back at a future date on agreed terms (such as a set price or timeframe).
• Often used as a way for companies to raise funds temporarily, or as part of employee incentive schemes.
• Terms (when and how they can be redeemed) must be set out in the company’s articles of association or the terms of issue.

Sometimes, preference shares are also redeemable, meaning they combine both features. It’s essential that any rights and restrictions are clearly defined – ideally with advice from a legal expert who knows your unique circumstances.

What Are the Main Benefits of Preferred Stock?

The main reason companies issue preferred shares and investors buy them is the unique benefits on offer:

• Priority on Dividends: Preferred shareholders receive dividends before any payments go to ordinary shareholders. This can help stabilise income, making them attractive to risk-averse investors.
• More Predictable Returns: With a fixed dividend rate, preferred shares can be less volatile than ordinary shares, which depend on the company’s profits and board decisions.
• Rank Higher in Liquidation: If the company is wound up, preferred shareholders stand ahead of ordinary shareholders in the pay-out queue, potentially lowering exposure to total loss.
• Appeal to Investors: Companies can use preferred shares as a way to entice investment without giving up control (since voting rights are usually limited or excluded).
• Customisable Terms: You can set special privileges-like redemption rights, conversion options, or cumulative dividend provisions-that can be tailored to your needs and those of your investors.

What Are the Key Risks & Limitations of Preferred Stock?

While preference shares offer significant perks, there are important limitations to keep in mind:

• Limited Voting Rights: In most cases, preferred shareholders don’t get a say in how the business is run. If control matters to you, it’s worth considering ordinary shares instead.
• Ranking in Liquidation: Although preferred shareholders rank above ordinary shareholders in a wind-up, they’re still behind secured and unsecured creditors. You’re not guaranteed repayment if the company’s debts exceed its assets.
• Dividend Payments Not Always Guaranteed: If a company has no distributable profits, it often cannot pay dividends at all. In some cases, preferred dividends are “cumulative” (meaning unpaid dividends roll forward), but this must be expressly stated. Non-cumulative shares simply miss out in these years.
• Potential for Dilution: Rights can vary, so always check whether the terms allow for the company to issue more shares and potentially dilute your claim on dividends or assets.
• No Upside on Company Success: If your preference shares are only entitled to fixed dividends, you won’t benefit directly from major increases in revenue or explosive company growth.

In short, the degree of risk and reward with preferred shares depends on the terms-the key point is to have everything clearly set out, ideally by professionally-drafted documentation.

What’s the Difference Between Cumulative and Non-Cumulative Preferred Shares?

One common feature you’ll see are “cumulative” preferred shares. Here’s what that means:

• Cumulative preference shares: If the company skips a dividend in one year (due to a lack of profits, for example), this unpaid dividend is carried forward to future years. Those unpaid amounts must be paid in full before any dividend is paid to the ordinary shareholders.
• Non-cumulative preference shares: If the company doesn't declare a dividend in a given year, the right to that dividend is lost forever-it doesn’t “roll forward.” Ordinary shareholders can only be paid if the current year’s preference dividend is paid in full.

The type is defined in your company’s articles of association or the terms of share issue. If you want more predictability in your income as an investor, cumulative preference shares offer a layer of protection-but companies might be less keen to offer them for precisely that reason!

How Can Preferred Shares Be Customised?

Unlike off-the-shelf products, preferred share rights can often be tailored to suit your company’s needs, subject to English company law and your company’s articles. Here are some of the ways preferred shares can be customised in practice:

• Redemption Rights: Some preferred shares can be bought back (“redeemed”) by the company, either at a set date or upon agreement between the holder and the business.
• Conversion Rights: These allow holders to convert their preferred shares into ordinary shares, usually at a pre-agreed ratio (handy if the company grows rapidly and preference holders want to “join in the upside”).
• Participation Rights: In rare cases, preferred shareholders may be entitled to share in extra profits after ordinary shareholders have received their dividends.
• Special Voting Rights: While unusual, some preference shares carry voting rights on specific matters (e.g., if the company is in default of dividend payments).

Be aware that any bespoke rights should be clearly recorded and included in the company's official documents and filings. Ambiguous or poorly-drafted share terms can lead to disputes or unintended outcomes, so always get the terms reviewed by an expert.

Why Do UK Companies Issue Preferred Shares?

So, why might your business consider issuing preferred shares? Here are some common scenarios:

• Raising Capital Without Losing Control: Founders can attract vital investment while retaining the majority of decision-making power, since preferred shares often lack voting rights.
• Appealing to Conservative Investors: Investors who prioritise stability and safety may prefer the predictable returns and protective features of preferred stock.
• Accommodating Different Shareholder Needs: Not all investors want the risk and variability of ordinary shares. Offering both types lets you broaden your pool of potential backers.
• Employee Incentive Schemes: Sometimes, preference shares are used in creative ways to offer employees a stake in the business with specific advantages (or limitations).
• Structuring Family or Private Businesses: Preference shares can be a practical tool in dividing up income streams, separating company control, or planning for succession.

If you’re thinking of attracting outside investment, it’s vital to offer the right share terms and to record them clearly in your company’s legal documents.

What Legal Documents Govern Preferred Shares?

In the UK, the main legal documents governing preferred stock are:

• Articles of Association: This core constitutional document sets out the types of shares your company can issue, and what rights and obligations attach to each class.
• Shareholders’ Agreements: While optional, these are highly recommended. A well-drafted agreement supports the articles by spelling out rules for dividend distribution, dispute resolution, transfer of shares, and more. For info on what to include, see our guide to shareholders’ agreements.
• Terms of Issue: Each round of share issuance (especially to new outside investors) should have written terms outlining the rights, restrictions, and conditions for those shares.

Issuing or amending preferred shares typically requires a special resolution (at least 75% shareholder approval) and must comply with the Companies Act 2006 and related regulations. Serious mistakes with share classes can have tax, compliance, and commercial consequences-so don’t leave this to chance! Early legal advice will help avoid costly errors and support your business for the long term.

Are There Downsides to Using Preferred Stock?

Of course, no funding method (or investment type) is all upside. Here are some risks or “watch-outs” for both companies and investors:

• For Companies:
  • Committing to fixed dividends can be a financial strain, especially if profits hit a rough patch and you’ve issued cumulative preferred shares.
  • Poorly drafted share terms can lead to disputes, especially if they’re ambiguous or out of step with your articles of association.
  • Some investors may see limited voting rights as a negative, making the shares less attractive to certain groups.
• For Investors:
  • Lack of voting rights means no real say in how the company is run.
  • Risk of missed dividends with non-cumulative shares if the company has a tough year financially.
  • In liquidation, claims are behind creditors and still carry risk if the company’s assets don’t cover all debts.
  • Limited benefit from company growth, since returns are typically fixed (unless the terms allow conversion to ordinary shares).

Ultimately, the suitability of preferred stock depends on your business goals, risk appetite, and the fine print in your company’s legal docs.

What’s the Process for Issuing Preferred Shares in the UK?

Here’s a quick rundown of what’s involved if you’re thinking about issuing preference shares:

1. Check Your Articles of Association: Make sure your company has authority to issue different share classes and that the precise rights are allowed by your governing documents. You might need to amend your articles first.
2. Draft Terms of Issue: Spell out all rights, dividend rates, voting entitlements, redemption or conversion features, etc. Avoid templates-everything should fit your business context. Consider a properly-drafted share subscription agreement.
3. Get Shareholder Approval: Typically, you’ll need a special resolution at a general meeting.
4. File With Companies House: Notify Companies House and update your statutory registers to reflect the new share issue and class rights.
5. Keep Investors Informed: If you’re welcoming new investors, make sure everyone understands the terms, risks, and procedures for their investment (learn more about raising capital here).

It can be tricky to get this process right, especially if amending your articles or negotiating complex terms. Legal review is not just a nice-to-have-it’s vital protection for both founders and investors.

Key Takeaways

• Preferred stock (“preference shares”) are a flexible tool in the UK, providing priority dividend payments and a higher claim on assets over ordinary shareholders.
• Preferred shares usually lack voting rights, but offer more predictable income and can be customised to suit different needs and situations.
• Cumulative preferred shares mean missed dividends are carried forward; non-cumulative shares forfeit missed dividends forever.
• The company’s articles of association and the terms of issue are essential in controlling the rights and obligations for each share class.
• Using the wrong (or unclear) documentation can cause commercial disputes, tax headaches, and regulatory trouble.
• If you’re unsure which share structure is right for your business or how to set up preferred stock, consulting a corporate lawyer saves time, money, and hassle down the road.

Need Help With Preferred Shares or Company Structure?

Setting up the right share structure can be a game-changer for your business. If you need advice or want to make sure your company is protected from day one, we’re here to help.

Get in touch at team@sprintlaw.co.uk or call us on 08081347754 for a free, no-obligation chat with our friendly legal team.