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Preference Shares: Benefits for issuers and investors

How preference shares work, and why they’re so popular among issuers and investors alike.

Let’s say you’re looking to raise capital for your business, there are a couple of avenues open to you:

  1. You could approach a bank for a loan, but that might not be the right solution for you.
  2. Venture capital is an option, but pricing your equity pre-growth is an expensive way to raise capital and the market appetite for start-ups in your sector might not be there.
  3. Maybe you’ve grown beyond the start-up phase, but you don’t have a long enough track record to appeal to a private equity investor.
  4. Or maybe your business has been around long enough to validate your product/market fit, and you now need a capital injection to fund your growth. However, the expense and time required to go the public listing route may simply be too much of an ask at this phase of your business growth.
 

What do you do?

One solution: Raise capital directly from the market by issuing a Smart Asset on Mesh. Either in the form of a tokenised debt instrument like a corporate bond, or in the form of a smart class of tokenised equities called preference shares.

“A preference share gives you a lot of flexibility in terms of its structure,” says Mesh MD Connie Bloem. “Many of the preference shares we see in the market behave like bonds, but work within a different regulatory framework; you’re still issuing equity to the market, even though it takes on some of the attributes of a debt instrument. We also see preference shares that look more like an equity structure, with certain associated benefits baked in.”

The legal framework is a key consideration here. “From a regulatory perspective, the big difference in deciding whether to issue pref shares or a bond lies in the purpose of the company and the use of the funds,” explains Arno Visser, Head of Legal at Mesh. “What do you need the money for? If, for example, you’re raising money to use as operating capital, you would likely fall within the Commercial Paper Act. But if you intend to lend the funds out to earn interest, then your best option is to issue preference shares instead.”


The Investor Case For Preference Shares

If you’re an investor, a preference share offers you additional rights, giving you preference over other shareholders. Mesh co-founder Andries Brink explains: “Normally owning shares in a company would give you the ability to vote on important matters through your representation at the board, and it would give you the ability to earn a dividend, should the company declare one. So a preference share gives you further rights.”

Those further rights could be just about anything, he says. “Typically it’s something like, ‘In addition to your dividend rights, you get a further interest rate payment’; or, ‘In addition to your interest rate payment, you have the ability to convert your preferred stock into a normal stock at a certain ratio’. Maybe you are holding one preference share and if you convert it, you get two normal shares. Whatever the further rights are, they are typically to the benefit of the shareholder.”

Bloem says that preference shares are an ideal asset type for the private capital and alternative finance market. “The magic of the private capital and alternative finance market is that it gives investors a way to invest in businesses that they previously did not have access to,” she says. “These businesses may be smaller, they may be earlier in their lifecycle, or they may be building something that’s a bit more interesting than what you’d generally be able to find. For investors to get the full economic benefit of investing in these assets, they also want to reduce their risks. In that case, preference shares can be structured to manage some of these risks, and to ensure that when the issuer goes to market, there’s a higher likelihood of investors being able to invest in that asset for a longer term.”


The Extra “Kicker” Of Preference Shares

“These instruments are, given where the market is at the moment, very popular with both issuers and investors,” says Brink. “As the investor, you’re saying: ‘I want a kicker. I want that kicker to be in the form of equity or in the form of interest, so I’m happy with the price and interest rate, but I want an equity kicker. Or I’m happy with the equity risk, but I want an interest rate kicker.’”
Preference shares can be portable, callable, or convertible at different ratios. “They have all sorts of features and are quite difficult to construct – certainly when they’re in the form of a Smart Asset,” says Brink.

But Mesh has done that, making preference shares available in our digital capital markets ecosystem – and in doing so, making capital markets more flexible and more accessible for investors and issuers alike.

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