Retractable Preferred Shares: Definition, And How Does it Work?

Definition

Retractable Preferred Shares are defined as a share class that has 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 to be 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, as well as the accumulated dividends, if they are 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, and hence, they would then 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 if any.

Features of Retractable Preferred Shares

As mentioned earlier, it can be seen that retractable preferred shares have the main objective to provide the issuing party the liberty to repurchase this type of shares 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 prices, unless there is one circumstance.
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How do Retractable Preferred Shares work?

Preferred shares functionality can best be described to be similar to a fixed-income bond that renders dividends, other than interest.

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

Given the fact 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, and hence, they raise offers for retractable preferred shares so that they are able to raise finance.

In the same manner, it can also be seen that retractable preferred shares are utilized by companies as a result of 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 the fact that it allows them to get finances at a cheaper finance cost.

Consequently, these shares can be repurchased upon maturity date, so this implies that the shareholding structure and dynamics within the company are meant to stay similar across the course of time.

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

In the same manner, retractable preferred shares are also an attractive option for investors because they act similar to fixed-income bonds, but they have a higher return, in accordance with the risk-return profile.

Limitations of Retractable Preferred Shares

The main limitation of retractable preferred shares is the fact that companies mostly issue these shares based on the premise that 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 particular case, organizations often end up selling their common equity, against the retractable preferred shares.

This eventually leads to dilution of shareholding, and this might not be well received with the existing shareholders.

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