What are Retractable Preferred Shares? Definition, And How Does it Work?

Definition

Retractable Preferred Shares are a share class with a maturity date. When these shares mature, the issuing company has the discretion to ask the retractable preferred shareholders to convert their shares into cash, or some other form of equity that the company offers.

Hence, it is not considered a permanent investment and gives the company the leverage to decide if they want to buy back those shares once they mature.

Upon maturity, it can be seen that retractable preferred shares are exchanged for cash. Upon maturity, preferred shareholders receive the face value of the shares and the accumulated dividends, if applicable.

The main rationale behind a company issuing preferred shares is the fact that the company might not have the resources to pay for certain expenses currently.

However, the company might expect to receive cash in the coming future so that they would purchase back those shares.

In other words, it can be seen that retractable preferred shares are in place to solve any short-term liquidity issues of the company.

Features of Retractable Preferred Shares

As mentioned earlier, it can be seen that retractable preferred shares have the main objective of providing the issuing party the liberty to repurchase this type of share at the end of the maturity date.

Therefore, retractable preferred shares have the following salient features:

  • They have a maturity date – other conventional equity instruments do not have a set maturity date.
  • Retractable Maturity Shares accumulate dividends over time. Upon maturity, the dividend and the face value of the share are subsequently paid out to the shareholders.
  • These shares normally provide options to get cash reimbursement against those shares. However, some issuing parties also give the option to buy common stock against these shares.
  • Retractable Preferred Shares normally stay around the same threshold, as mentioned in the prospectus. Unlike other stocks, they do not fluctuate in price, unless there is one circumstance.
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How do Retractable Preferred Shares work?

A preferred share’s functionality can best be described as similar to a fixed-income bond that renders dividends, other than interest.

Therefore, their valuation remains steady since it is not contingent on, or tied alongside the lines of prevalent interest rates.

Given that all the cumulative amount is distributed as cash, retractable preferred shares can be redeemed for cash, if the option is readily available.

The main reason why businesses opt for retractable preferred shares is the fact that they are currently lacking in resources.

Hence, they raise offers for retractable preferred shares so that they can raise finance.

In the same manner, it can also be seen that companies utilize retractable preferred shares due to their expectation that they will be able to pay back the amount raised at the end of the due time.

Therefore, whenever organizations plan on issuing these shares, they issue a prospectus, and call for applications, after they have completed all the legal requirements.

After they get purchase intent from individuals, they sell those shares.

They then cumulate all dividends, and then pay back the face value of the share, in addition to the cumulative dividends to the shareholders upon maturity.

Advantages of Retractable Preferred Shares

The main rationale behind businesses working with retractable preferred shares is that it allows them to get finances at a cheaper cost.

Consequently, these shares can be repurchased upon maturity date, implying that the shareholding structure and dynamics within the company are meant to stay similar over time.

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This is because the net effect of the retractable shares is zero since all those shares are repurchased.

Similarly, retractable preferred shares are also an attractive option for investors because they act similarly to fixed-income bonds. Still, they have a higher return, to the risk-return profile.

Limitations of Retractable Preferred Shares

The main limitation of retractable preferred shares is that companies mostly issue them because they will have money to pay back to repurchase the retractable preferred shares after the maturity date.

However, that might not always be the case, and there are times when companies do not have liquid resources to repurchase the stock.

In that case, organizations often sell their common equity, against the retractable preferred shares.

This eventually leads to dilution of shareholding, which the existing shareholders might not well receive.