In the world of startup funding, it’s not only the innovations that require close attention, understanding the financial instruments involved in funding rounds is just as critical. One such instrument is preference shares, a key concept every startup founder, investor and venture capitalist (VC) should be familiar with.
With the current surge in VC activity and a number of notable funding rounds in 2025 already closed, understanding how preference shares work and their implications on equity, control and liquidation is more important than ever.
What are Preference Shares in South Africa?
In the South African context,preference shares are defined as a type of stock that provides shareholders preferential treatment compared to ordinary shareholders, particularly in terms of dividend payments and the distribution of assets in the event of liquidation.
While preference shares are technically equity, they have the characteristics of both equity and debt, making them a hybrid financing instrument. Their specific rights and features need to be outlined in a company’s Memorandum of Incorporation (MOI) or in the terms of the share issuance agreement.
Key Features of Preference Shares
In South Africa, there are variouscharacteristics that set preference shares apart from other types of securities. These include:
Priority in liquidation – Preference share owners have a right to get their share of the firm’s assets before ordinary shareholders in the event of liquidation.
Dividend payments – Dividends are typically fixed or floating and are often based on an interest rate benchmark such as South African Benchmark Overnight Rate (SABOR).
Preferential dividends – Preference shareowners receive dividends before ordinary shareholders.
Non-voting rights – Preference shares do not carry any voting rights, but an exception can be made in extraordinary events.
Conversion – In some cases, preference shares can be converted into a predetermined number of ordinary stocks. The conversion is subject to specified conditions or approval from the board.
Callability – The issuer of the preference shares can repurchase them at specified dates.
It’s important to remember that the terms of preference shares can vary depending on the issuing company and the terms for each share issuance.
There are varioustypes of preference shares, each with its own set of features. The different types are:
Cumulative preference shares – These are preference shares that ensure that any unpaid dividends accumulate and must be paid in future years before ordinary shareowners receive theirs.
Non-cumulative preference shares – These shares don’t accumulate unpaid dividends. If the firm fails to pay in a particular year, preference shareholders cannot claim unpaid dividends in the future.
Convertible preference shares – This agreement gives preference shareowners the option to convert their shares into common stock at a predetermined conversion rate.
Participating preference shares – This gives preference shareholders the opportunity to receive additional dividends if the company achieves profitability.
Tax Implications and Legal Framework
In South Africa, preference shares are a type of hybrid financing instrument and are classified as equity for tax reasons. Under Section 8E of the Income Tax Act, preference shares are deemed as income in the hands of the holder of the shares.
Section 8E (1) of the Act further stipulated that a preference share secured by a financial instrument which cannot be disposed of, unless the shares were issued for a qualifying purpose, is classified as a hybrid debt instrument. Aqualifying purpose refers to the direct or indirect acquisition of shares in operating companies.
This tax treatment ensures that preference shares do not offer tax-avoidance loopholes, while still incentivising equity investment.
Governance Rights and Voting Rights
As stated above, preference shareholders do not have voting rights, however, they can be given such rights. Since preference shares form part of a company’s capital, holders can be given rights to vote on specific matters outlined in the company’s constitutional documents.
For example, preference shareholders may:
Vote on amendments to the rights attached to their shares
Appoint directors
Vote at general meetings or in an extraordinary case.
This flexibility allows both founders and investors to craft custom governance structures that align with strategic goals and protect downside risk.
Regulatory Requirements for Investors
Much like other financial instruments, preference shares also adhere to various laws and regulations.
For investors who are South African residents, there are no applicable requirements. Non-South African investors must comply with exchange control regulations administered by the South African Reserve Bank (SARB).
Non-residents must:
Receive a share certificate from the SARB’s Financial Surveillance Department or an authorised dealer.
Complete the process within 30 days of acquiring the shares.
In terms of Regulation 14(1) of the Exchange Control Regulations, no person may acquire or dispose of shares in a South African company with SARB’s permission or any authorised person.
Currency and Exchange Control
According to the Companies Act, share capital including preference shares must be denominated in South African Rands (ZAR).
If an investor wants to acquire preference shares in another currency like the US Dollar, the amount must be equivalent to the Rand-denominated value, and prior approval must be obtained from the SARB’s Financial Surveillance Department for currency conversion.
Transfer Restrictions
Transferability of preference shares depends on the status of the issuing company:
Private companies - Transfers are subject to board approval and may be limited to a list of pre-approved shareholders as stated in the company’s MOI.
Public companies - Preference shares are generally freely transferable, subject to relevant listing and securities regulations.
Startups, especially those in early growth stages, often issue preference shares with transfer restrictions to maintain control and prevent unwanted shareholder shifts.
Why Preference Shares Matter?
For startups, the inclusion of preference shares in a funding round can significantly impact future equity structure, control rights and exit scenarios. Founders must be clear on the rights they are granting, especially in relation to liquidation preferences and future funding rounds.
For investors, preference shares offer a lower-risk option with built-in protections. They combine aspects of debt (regular dividends and capital protection) with potential equity upside (in the case of conversion or participation rights).
With South Africa’s maturing VC landscape, preference shares are going to be more common. And while they may seem complex, understanding their features, tax and governance implications is vital for both founders and investors.
Whether you are strategising for your next funding round or considering your first equity investment, preference shares are not just an option, they’re also the key to balancing startup growth with investor protection.
Lungile is the Digital Editor for TechAfrica, with a knack for storytelling, technology and innovative ideas. Working with TechAfrica, she takes simple ideas and turns them into amazing stories.
Lungile Msomi
