Preference Shares Explained: Essential Guide for Australian Businesses

Looking to raise capital without giving up control? Preference shares can be a smart way for Australian companies to access funding, reward investors with predictable returns and keep voting power with existing owners.

In this guide, we’ll explain what preference shares are, the different types available, how they’re regulated under the Corporations Act 2001 (Cth), when redeemable preference shares make sense, and the practical steps to issue them properly. We’ll also flag key risks to consider so you can move forward with confidence.

What Are Preference Shares?

Preference shares (sometimes called “prefs”) are a class of shares that sit between debt and equity. Holders usually get priority dividends and priority on a return of capital if the company is wound up, ahead of ordinary shareholders.

Unlike ordinary shares, preference shares often have limited or no voting rights. That’s why they’re popular with founders who want capital but don’t want to dilute decision-making control.

Preference shares can be tailored to suit your goals. For investors, they can provide stable, fixed dividends. For companies, they can provide flexible funding without the covenants and security that often come with debt.

Under the Corporations Act, a company can issue shares with different rights if those rights are set out in its Company Constitution or in a resolution that approves the issue. Getting the right structure and documentation in place is crucial.

Common Types Of Preference Shares (And What They Mean)

There’s no single template for preference shares. The rights are set on issue and should be clearly described in the Constitution and offer documents. Below are common variations you’ll see in Australia.

Convertible vs Non-Convertible

• Convertible Preference Shares: Can convert into ordinary shares on agreed terms (e.g. at a fixed date, at the holder’s option, or on a funding or exit event). These offer fixed dividends now with potential equity upside later.
• Non-Convertible Preference Shares: Remain as preference shares for their life. Best for investors who value steady income over potential capital growth.

Cumulative vs Non-Cumulative

• Cumulative Preference Shares: If a dividend isn’t paid in a period, it accrues. Unpaid amounts must be made good before ordinary dividends are paid.
• Non-Cumulative Preference Shares: Missed dividends don’t accrue. If not declared, they’re lost for that period.

Participating vs Non-Participating

• Participating Preference Shares: Receive their fixed dividend and, if profits exceed a threshold, may also participate in extra dividends alongside ordinary shareholders.
• Non-Participating Preference Shares: Entitled only to their fixed dividend-even if profits are higher than expected.

Directors should ensure the rights are consistent with the company’s broader capital strategy. If you’re comparing options across your capital stack, our overview on different classes of shares is a helpful reference point.

Key Rights, Voting And The Australian Legal Framework

In Australia, the Corporations Act 2001 (Cth) allows companies to issue shares with different rights, including preference shares, provided the terms are properly authorised. In practice, you’ll set these rights in your Constitution or through a shareholder resolution that specifies the terms of issue.

Priority Rights Typically Attached To Preference Shares

• Dividend Priority: Preference dividends are paid before any dividends to ordinary shareholders. They may be fixed, floating or formula-based and can be cumulative or non-cumulative.
• Liquidation Preference: On a winding up, preference shareholders usually have priority to a return of capital ahead of ordinary shareholders (subject to the exact terms of issue).

Voting Rights: Limited, With Important Exceptions

Preference shareholders usually have limited or no votes on day-to-day matters. However, they commonly have voting rights:

• on any variation or cancellation of their rights,
• on proposals to wind up the company, and
• if dividends on the preference shares are in arrears for a set period (often specified in the terms).

These exceptions protect investors without shifting overall control, and they should be spelled out clearly in the terms of issue and the Constitution.

Where Do These Rights Live?

The “rule book” for your share classes is your Constitution (or a resolution setting terms where the Constitution permits). If your company doesn’t yet have a tailored Constitution, consider adopting one before issuing prefs so the rights are clear, consistent and enforceable.

If you have multiple owners or plan future raises, align your Constitution with your Shareholders Agreement so both documents work together on matters like dividends, information rights and exits.

ASIC Notifications And Record-Keeping

When you issue new shares, vary rights, redeem shares or change your share structure, you’ll need to update ASIC within the required timeframes. This is usually done via forms relating to changes to share structure-often referred to as ASIC Form 484 events. Keeping your register of members up to date is also essential.

Redeemable Preference Shares: How Redemption Works In Australia

Redeemable preference shares include a mechanism for the company to buy the shares back (redeem them) at a future time or on a trigger event, at a price set in the terms. They can be a useful “bridge” instrument for a defined period of capital.

Redemption Must Follow The Corporations Act

Under the Corporations Act, redemption is tightly regulated. Key points include:

• Fully Paid: Redeemable preference shares must be fully paid before redemption.
• Source Of Funds: Redemption can only be made out of profits or from the proceeds of a fresh issue of shares. It cannot be made out of capital. Using loan funds directly to redeem shares is not permitted (although a new share issue used to raise funds, followed by redemption, is contemplated by the Act).
• Terms Of Issue: Redemption must be in accordance with the terms set when the shares were issued (e.g. timing, price, triggers, notice requirements).
• Solvency: The directors must ensure redemption won’t make the company insolvent. You should have reasonable grounds to believe the company will remain solvent after the transaction.

Get the mechanics right at the drafting stage-clear redemption triggers, notice periods, pricing and the funding source will make future redemptions much smoother.

Dividends And Redemption

Redeemable preference shares often carry fixed dividends, which may be cumulative. Before redemption proceeds, check whether any accrued but unpaid dividends are required to be paid. Also consider any tax implications and dividend franking policies. For directors, it’s good governance to understand your company’s obligations when paying dividends so you remain compliant.

How To Issue Preference Shares (Step-By-Step)

Issuing preference shares is a legal process. Here’s a practical overview of the typical steps in Australia.

1) Align Your Constitution And Board Strategy

Confirm your Constitution allows different classes of shares and sets a process for issuing them. If it doesn’t, update it first so preference share rights can be clearly authorised. The board should agree on why you’re issuing prefs (e.g. fixed-income investors, bridge funding, strategic investor) and how they fit with your broader capital plan.

2) Set The Terms Of Issue

Design the rights to suit your goals and market expectations. Decide on key features such as:

• dividend rate and whether it’s cumulative,
• participating or non-participating,
• convertible or non-convertible (and conversion mechanics),
• redemption rights (if any) and redemption price,
• limited voting rights and the exceptions (e.g. variation of rights, winding up), and
• information rights and reporting frequency (if appropriate).

It’s common to capture high-level commercial terms in a term sheet, then translate them into legally binding documents.

3) Member Approvals (If Required)

Depending on your Constitution and the nature of the new rights, you may need shareholder approval, especially where issuing a new class of shares or varying rights of existing shares. Ensure the proper resolutions are prepared and passed.

4) Prepare And Execute Documents

You’ll typically need:

• a board resolution approving the issue and terms,
• updated Constitution or a resolution setting the rights (if needed),
• offer materials to prospective investors, and
• a Share Subscription Agreement (the contract under which investors subscribe for the shares).

When executing documents for the company, consider using section 127 Corporations Act execution to streamline signing and evidentiary issues-our explainer on signing documents under section 127 covers the essentials. It’s also worth understanding how company agents can bind the company under section 126 in relevant scenarios.

5) Allot The Shares And Update Records

Receive subscription monies, allot the shares, update your register of members, issue share certificates (if you use them) and lodge any required ASIC notifications for the share issue and new class/rights within the prescribed time (commonly lodged via events covered by ASIC Form 484).

6) Keep Documents In Sync

Make sure your Constitution, cap table, Shareholders Agreement and investor communications all reflect the same terms. Consistency prevents disputes and maintains investor confidence.

Benefits, Risks And Practical Tips

Why Companies Use Preference Shares

• Raise Capital Without Ceding Control: Limited voting rights help founders maintain decision-making power.
• Structured, Predictable Returns: Fixed (often cumulative) dividends can be attractive to investors seeking income.
• Flexible Design: Terms can be tailored-convertibility, redemption, participation-to match your growth plan.

Key Risks To Consider

• Dividend Pressure: Fixed or cumulative dividends create cash obligations. Stress-test your forecasts.
• Complexity: Poorly drafted terms can conflict with your Constitution or shareholder expectations.
• Future Rounds: New investors may ask for different rights. Try to design terms that won’t impede future raises.
• Redemption Constraints: Remember redemption must be out of profits or a fresh issue-plan early if you anticipate redeeming.

Practical Tips

• Plan The Capital Stack: Consider how preference shares sit alongside existing debt and ordinary equity.
• Keep It Clear: Use plain English summaries of key rights in investor materials to avoid misunderstanding.
• Document The Process: Board minutes, resolutions, subscription agreements and ASIC filings are part of “getting it right”.
• Think Ahead To Exit: If convertibility or redemption is involved, model different scenarios (IPO, trade sale, no exit for 5–7 years) to ensure terms remain workable.

If you’re still shaping your share classes for an early-stage raise, you might also be weighing founder allocations. Our guide on how to allocate shares in a startup can help you think about the cap table before (or alongside) introducing prefs.

Key Takeaways

• Preference shares give investors priority dividends and priority on return of capital, usually with limited voting rights that expand only in specific circumstances (e.g. varying their rights, winding up, or dividend arrears).
• Terms are flexible-convertible/non-convertible, cumulative/non-cumulative, participating/non-participating-but they must be authorised by your Constitution or shareholder resolution and kept consistent across documents.
• For redeemable preference shares, redemption must follow the Corporations Act: shares must be fully paid, redeemed only from profits or proceeds of a fresh issue (not out of capital), and the company must remain solvent after redemption.
• A clean process matters: board approvals, a clear Share Subscription Agreement, ASIC notifications (often via events that sit under ASIC Form 484), and accurate registers reduce risk and build investor trust.
• Align your Company Constitution and Shareholders Agreement so your preference share terms, decision-making rules and exit provisions all work together.
• Set terms with the future in mind-avoid features that could complicate later funding rounds or exits, and model dividends and redemptions against cash flow.

If you would like a consultation on preference shares for your company, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.