Cumulative Preference Shares And Other Types Of Preference Shares In NZ

If you’re raising capital for your startup or growing SME, you’ll eventually hit a fork in the road: do you issue ordinary shares, take on debt, or create a share class with special rights?

This is where cumulative preference shares (and other types of preference shares) often come up. They can be a practical way to attract investors, reward early backers, or structure a deal without giving away too much control on day one.

But preference shares are also one of those topics that can look deceptively simple until you’re staring at a term sheet, a cap table, and a constitution that doesn’t quite say what you thought it said.

Below, we’ll break down what cumulative preference shares are, how they commonly work in New Zealand, what other preference share types exist, and the key legal and commercial issues to think through before you issue them.

What Are Preference Shares (In Plain English)?

Preference shares are shares that come with “preferential” rights compared to ordinary shares.

In most NZ companies, ordinary shares are the default. Ordinary shareholders typically:

• vote on major company decisions (depending on the constitution and Companies Act settings);
• share in dividends if/when dividends are declared; and
• share in the distribution of value if the company is sold or wound up (after creditors are paid).

Preference shares can change that risk/return balance. They usually give the preference shareholder one or more of the following:

• priority for dividends (getting paid before ordinary shareholders);
• priority on liquidation/sale (getting money back before ordinary shareholders);
• fixed or formula-based returns (for example, a set percentage dividend); and/or
• special conversion or redemption rights (for example, converting into ordinary shares or being bought back).

For business owners, preference shares are essentially a way of saying: “We’ll give you different economic rights to match the level of risk you’re taking.”

Important: preference shares aren’t “one standard thing.” Their rights and restrictions usually depend heavily on:

• your share structure (classes of shares);
• your Company Constitution (this is often where class rights are set out);
• the share issuance documents and any investor term sheet; and
• your Shareholders Agreement (which often deals with control, exits, and protections).

What Are Cumulative Preference Shares?

Cumulative preference shares are preference shares where unpaid dividends can accrue over time (often called “dividend arrears”).

In other words, if the company doesn’t pay the dividend in a particular period, the shareholder doesn’t necessarily “lose” that dividend entitlement - it may carry forward and remain payable in the future, but only in accordance with the share terms and when the company can lawfully make a distribution.

How Cumulative Dividends Typically Work

Let’s use a simple example.

• Your company issues cumulative preference shares with a 10% annual dividend.
• Year 1: the company can’t afford (or can’t lawfully justify) paying dividends.
• Year 2: still no dividend paid.
• Year 3: the business becomes profitable and wants to pay dividends.

With cumulative preference shares, the unpaid dividends from Years 1 and 2 may accumulate. That can mean the preference shareholder is entitled to receive:

• Year 3 dividend, plus
• the “arrears” (unpaid accumulated dividends) from prior years,

before ordinary shareholders receive anything - assuming the board declares a dividend and the company satisfies the legal requirements to make a distribution at that time.

This is a key reason cumulative preference shares can be attractive to investors: they offer a stronger path to a return, even if the company delays dividends during growth years.

Are Cumulative Preference Shares “Debt-Like”?

They can feel debt-like, because the return builds up over time. But they’re still equity, not a loan.

That difference matters because:

• dividends are generally only payable if and when the board declares them and the company can lawfully make a distribution (more on this below);
• preference shareholders’ rights come from the share terms (not a lender/borrower relationship); and
• in an insolvency, creditors generally rank ahead of shareholders (even preference shareholders).

When Do Accumulated Dividends Get Paid?

This is one of the most important drafting questions with cumulative preference shares.

Depending on the terms, accumulated dividends might be payable:

• when the board declares dividends (and the company can lawfully make the distribution);
• on a sale or liquidation event (sometimes tied to liquidation preference);
• on redemption/buyback of the preference shares; and/or
• on conversion into ordinary shares (sometimes the arrears are waived; sometimes they’re paid out).

If you’re the founder, the key takeaway is: cumulative preference shares aren’t just “10% per year” - they’re a set of legal rights that can materially impact what’s left for ordinary shareholders later.

Other Common Preference Share Types You Might See In NZ

“Preference shares” is a broad umbrella. In practice, the rights are often mixed and matched. Here are some common preference share types (and features) you might come across as an NZ startup or SME.

Non-Cumulative Preference Shares

Non-cumulative preference shares are the opposite of cumulative. If a dividend isn’t paid for a particular period, it typically doesn’t carry forward.

This can be more founder-friendly, but it may be less attractive to investors who want a more predictable return profile.

Participating Preference Shares

Participating preference shares can allow an investor to get their preference amount and then also participate alongside ordinary shareholders in the remaining proceeds (for example, after a sale).

In simple terms, a participating preference can look like:

• first, the investor gets their “preference” return (often their investment back, sometimes with a multiple); and
• then, they share in what’s left with everyone else (sometimes on an as-converted basis).

These can be very significant economically, so it’s important you understand the “waterfall” (who gets paid what, and in what order) before agreeing to them.

Non-Participating Preference Shares

Non-participating preference shares generally mean the investor gets their preference amount or they convert to ordinary and take the ordinary outcome - but not both.

These are often seen as a more balanced approach, especially for early-stage funding.

Convertible Preference Shares

Convertible preference shares can convert into ordinary shares, usually:

• automatically on an IPO or qualifying fundraising round; and/or
• optionally at the investor’s election.

From a founder’s perspective, convertible preference shares can make sense where you want to give downside protection to investors early, but ultimately have a simpler ordinary share structure later.

If you’re also allocating equity to team members, you may want to map these rights against your incentive structure (for example, a Share Vesting Agreement) so everyone understands how value and control could change over time.

Redeemable Preference Shares

Redeemable preference shares allow (or require) the company to redeem (buy back) the shares at a certain time or on certain terms.

This can be useful when an investor wants a defined “exit” without forcing a full company sale.

However, redemptions and buybacks have legal, procedural, and cashflow constraints (including solvency requirements). The terms need to be carefully aligned with what the company can realistically fund.

Preference Shares With A Liquidation Preference

A liquidation preference is a right to be paid first if there’s a “liquidation event” (commonly a sale of the company, winding up, or sometimes a major asset sale).

Liquidation preferences are often described as:

• 1x (get back the original investment amount first);
• 2x (get back double the investment amount first); or
• plus accrued dividends (common where cumulative preference shares are involved).

Even a “standard” liquidation preference can materially change founder outcomes in an exit. This is why it’s worth modelling scenarios (good exit, ok exit, disappointing exit) before signing anything.

How Preference Shares Work Under NZ Company Law

In New Zealand, the key legislation is the Companies Act 1993. Rather than getting lost in legal jargon, here are the practical points founders and SME owners should focus on.

Your Constitution Usually Does The Heavy Lifting

If you want multiple share classes (for example, ordinary shares and cumulative preference shares), the company’s constitution is typically where those class rights are clearly recorded.

If you don’t have a constitution (or if your constitution doesn’t properly deal with multiple classes), you can quickly run into issues like:

• uncertainty about dividend rights;
• unclear voting rights (or “class vote” requirements);
• disputes about what happens on a sale; and
• difficulty bringing in new investors cleanly.

Getting the share rights right from day one can save you a lot of time (and negotiation pain) later.

Issuing Shares Is A Formal Company Process

Issuing a new class of shares isn’t just a handshake deal. There are corporate steps that need to be followed, including director approvals and proper documentation.

As a general guide, you’ll want to treat a preference share issue as part of a proper Company Issue Of Shares process, including getting the terms right and ensuring your records (like the share register) are accurate.

Dividends And Distributions Must Be Made Properly

This is a big one for cumulative preference shares.

Even if dividends are “cumulative” on paper, that doesn’t mean you can pay them whenever you like. In general, a company must meet the Companies Act requirements for a distribution (including the solvency test) at the time the dividend is declared and paid.

Practically, this means:

• your preference shareholder might have an entitlement that can accrue under the share terms; but
• the timing and ability to actually pay will still depend on whether the board declares a dividend and the company’s financial position at that time.

This is one reason why preference share terms should be drafted carefully - so expectations are realistic on both sides.

Changing Rights Can Trigger Extra Requirements

Once you’ve issued a class of shares, those shareholders often have “class rights.” Changing those rights later can require additional approvals.

If you’re a founder, it’s worth thinking ahead. For example:

• If you later want to raise another round with a new preference class, will the existing preference shareholders have veto rights?
• If you want to simplify the cap table before a sale, can you convert the preference shares easily?

This is also where a well-drafted Shareholders Agreement is extremely helpful, because it can set clear rules about funding rounds, exits, transfers, and decision-making.

When Do Cumulative Preference Shares Make Sense (And When Don’t They)?

Cumulative preference shares can be a smart tool - but they’re not always the right fit.

Here are some common situations where they can make sense for NZ startups and SMEs.

You’re Raising Capital From Investors Who Want Downside Protection

If an investor is putting in meaningful money early (when the risk is high), they may want stronger rights than ordinary shares offer. Cumulative preference shares can be one way to bridge that gap without overhauling control rights.

You Want To Avoid Debt But Still Offer A “Return Profile”

Traditional debt comes with fixed repayment obligations. For many growing businesses, that cashflow pressure is risky.

Cumulative preference shares can sometimes be structured to offer an investor a return expectation without the same hard repayment schedule as a loan (though you still need to be careful about how the terms operate in reality).

You’re Bringing In A Strategic Investor And Need Flexibility

A strategic investor might care about:

• a priority return;
• clear exit mechanics; and
• a pathway to convert into ordinary shares if the business takes off.

A tailored preference share class can do that - provided the documents match the commercial deal.

When Cumulative Preference Shares Might Create Problems

On the flip side, cumulative preference shares can cause issues when:

• your business is planning to reinvest profits for years (dividend arrears can stack up and make later dividends or exits more complicated);
• you want a simple cap table for future funding (complex preference rights can slow down later rounds);
• you’re offering employee equity (preference rights can mean ordinary shares carry less real economic upside than people expect); or
• you haven’t properly documented transfer/exits (for example, if an investor wants to sell their preference shares, your process for How To Transfer Shares matters a lot).

The core idea is simple: preference shares can be great for attracting investment, but they can also “hard-code” economics into your company in a way that’s difficult to unwind later.

What Documents Should NZ Startups And SMEs Put In Place?

If you’re considering issuing cumulative preference shares (or any preference share type), it’s worth slowing down and making sure your legal foundations match your funding goals.

In most cases, the key documents to think about include:

A Company Constitution With Clear Share Class Rights

Your Company Constitution should clearly set out (or allow for) the rights attached to each share class.

For preference shares, this often includes:

• dividend rights (including whether they’re cumulative);
• priority on liquidation or sale (liquidation preference);
• voting rights and “class vote” matters;
• conversion mechanics (if any); and
• redemption/buyback mechanics (if any).

A Shareholders Agreement (To Prevent Disputes Later)

A constitution is important, but it doesn’t always cover the “relationship rules” between shareholders in a practical way.

A well-drafted Shareholders Agreement can deal with things like:

• who controls day-to-day decisions vs reserved matters needing investor consent;
• how future funding rounds happen (and what happens if someone doesn’t participate);
• information rights (what financial reporting investors receive);
• exit pathways (trade sale, management buyout, etc.); and
• deadlock resolution (so disagreements don’t stall the business).

Share Issuance Documents And Cap Table Records

Whenever you issue shares, you’ll want the paperwork to match what you’ve agreed commercially - and your internal records to stay clean.

This becomes even more critical with multiple classes, because “who owns what” isn’t just about percentage ownership. It’s also about rights.

As your company grows, it’s also worth staying on top of structural basics like How Many Shares Can A Company Have, because founders often discover too late that their original share structure makes later fundraising or employee equity harder than it needs to be.

Consider Whether You Need Separate Investment Documents

Depending on the deal, you might also need specific investment documents (for example, subscription terms or a formal share subscription agreement), especially where there are conditions, milestones, or special rights that need to be enforceable.

The right approach will depend on your investor type, timeline, and growth plans - so it’s a good idea to get tailored advice before you lock in terms you’ll live with for years.

Key Takeaways

• Cumulative preference shares are preference shares where unpaid dividends can accrue over time (dividend arrears), which may increase what investors receive later (often before ordinary shareholders), subject to the share terms and the company meeting the legal requirements to pay dividends.
• Preference shares are highly customisable, and their real-world impact depends on the exact terms around dividends, conversion, liquidation preference, and redemption.
• In New Zealand, preference share rights usually need to be properly reflected in your constitution and supported by well-drafted investment and shareholder documents.
• Even if dividends are “cumulative,” dividends generally only become payable if and when they’re declared and the company can lawfully make a distribution - and cashflow realities matter.
• Complex preference terms can help you raise money, but they can also complicate future rounds, employee equity, and exits - so it’s worth modelling outcomes before you commit.
• Getting your legal foundations right from day one (share classes, approvals, records, and agreements) is one of the best ways to prevent disputes and keep your fundraising options open.

General information only: This article is general information and doesn’t take into account your specific circumstances. It isn’t legal, tax, accounting, or financial advice. Because preference share terms can materially affect dividends, control, and exit outcomes, it’s a good idea to get tailored advice before issuing shares or signing a term sheet.

If you’d like help structuring or issuing cumulative preference shares (or reviewing preference share terms before you sign), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.