When a company needs to raise more funds, it can either take out a loan (debt financing) or issue more shares in exchange for funds (either through a public or private issue of shares).
Preference shares are really debt instruments.
These shareholders advance funds to the company and in return, they get the first bite of the profits in the form of dividends (called the preferred dividend – the rate negotiated on a case by case basis).
Also, if the company goes belly-up or gets sold, preference shareholders will usually be paid out ahead of ordinary shareholders (called the liquidation preference – which can even be in multiples i.e. a preference shareholder could negotiate receiving two times his investment prior to ordinary shareholders getting a piece of the pie).
So, simply put, preference shares trump ordinary shares as they normally receive preferential treatment at a distribution or liquidation event.
There are a couple of additional characteristics that could come in to play and it is important to have a proper understanding of these characteristics when negotiating with investors.
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