When a company seeks to raise capital, it generally has two primary options: debt financing (such as bank loans or debentures) or equity financing (by issuing shares). Among the various equity instruments available, preference shares offer a unique hybrid structure that incorporates both debt- and equity-like features.

What Are Preference Shares?

Although classified as equity, preference shares function in many ways like debt instruments. They are typically issued to investors who advance capital to a company in exchange for defined economic rights, most notably, a fixed preferential dividend. This dividend is often agreed upon upfront and may be payable on a cumulative or non-cumulative basis, depending on the terms negotiated between the parties.

Priority on Profits and Liquidation

The hallmark of preference shares is their priority ranking over ordinary shares:

• Dividends: Preference shareholders are entitled to receive dividends before any profits are distributed to ordinary shareholders.
• Liquidation Preference: In the event of a liquidation, winding-up, or sale of the company, preference shareholders are entitled to be repaid ahead of ordinary shareholders. This repayment can even be structured in multiples, e.g., a “2x liquidation preference” entitles a preference shareholder to receive twice their original investment before any distribution is made to common equity holders.

Why Do Preference Shares Matter?

From a company’s perspective, issuing preference shares can be an effective way to secure funding without immediately diluting control, since preference shareholders typically do not have voting rights (unless stipulated otherwise). For investors, preference shares offer a more secure and predictable return, especially in high-risk or early-stage ventures.

However, these benefits are accompanied by complex legal and commercial implications. Features such as convertibility, redemption rights, anti-dilution provisions, and participation rights often accompany preference shares, and must be clearly defined in the company’s constitutional documents and shareholders’ agreements.

Legal Considerations in Lesotho

While Lesotho’s corporate law regime, principally governed by the Companies Act 18 of 2011 permits the issuance of preference shares, companies must ensure that their Articles of Incorporation (AOI) and shareholder agreements are properly structured to reflect the agreed terms. It is advisable to consult legal counsel when drafting or reviewing such instruments to ensure compliance with local regulatory requirements and to safeguard the interests of all parties involved.

Interested in Raising Capital or Negotiating Investor Terms?

Our Corporate and Commercial Law team advises on all aspects of equity structuring, including the issuance and regulation of preference shares. Contact us to schedule a consultation.