How preferred shares affect the bottom line at tech companies looking to list in Hong Kong

Investors should pay attention to recurrent income of core operation, which shows company’s performance

PUBLISHED : Thursday, 03 May, 2018, 5:30pm
UPDATED : Thursday, 03 May, 2018, 5:30pm

Preferred shares, also known as preference shares, are not a new financial instrument, but they have become popular because an increasing number of technology companies issue them to raise funds ahead of an initial public offering.

Paul Lau, partner and head of capital markets at KPMG China, explains what this instrument is and how it affects a technology company’s bottom line.

What is a preferred/preference share?

It is a share class of ownership in a company that has a higher claim on its assets and earnings than ordinary shares, and generally entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends.

Why do technology companies issue these shares?

Technology companies often issue preferred shares, or preference shares, as part of their pre-IPO financing. These come with certain features, such as convertibility into common shares, and are redeemable at the option of the holder at some future date if there is no IPO. These features give the investor an exit plan, which includes their preference shares being converted into listed ordinary shares upon an IPO.

How does it affect a technology company’s profit and loss account?

The accounting for these shares is complicated and, in some cases, will result in the shares in their entirety, or some component thereof, being accounted for at their fair market value, with changes in the fair value being recorded as an expense in the profit and loss account. For many technology companies, as the valuation of the company increases, the fair value of these financial instruments tends to increase, which means a larger profit and loss charge.

How does this affect investors?

The profit and loss charge is not an operating expense and is non-cash in nature, and this accounting treatment will not go forward after an IPO, as the preference shares are converted into ordinary shares upon listing. As for investors, they should pay attention to what is the recurrent income of the core operation, which reflects the company’s operating performance.