Are Preference Shares Debt Or Equity In New Zealand?

If you’re raising capital for your New Zealand startup or growing SME, you’ll probably hear the same funding buzzwords on repeat: “equity round”, “debt facility”, “convertible”, and often… “preference shares”.

Here’s where many founders get stuck: preference shares don’t always feel like “normal” shares. They can have fixed-looking returns, priority on exits, and protective rights that can make them look and behave a bit like a loan.

So, are preference shares debt or equity?

The helpful (and very lawyerly) answer is: preference shares are generally equity, but the exact rights attached can make them look “debt-like” in practice. And the details matter, because they affect:

• how your cap table works (and who really controls what),
• what happens in a sale or liquidation,
• how investors and lenders view your business,
• how you draft your governance documents, and
• your future fundraising options.

Below, we’ll break down what preference shares are in plain English, why the question of whether preference shares are debt or equity comes up so often, and what you should watch for before you sign anything.

What Are Preference Shares (In Plain English)?

Preference shares are shares issued by a company that come with “preferred” rights compared to ordinary shares.

That “preference” usually relates to money and risk. Investors often want priority if things go well (a sale or IPO) and if things go badly (a liquidation). Preference shares are one of the most common ways to structure that.

In New Zealand, shares (including preference shares) are created and governed under the Companies Act 1993, but the practical rights are usually set out across multiple documents, including your constitution (if you have one) and your shareholders’ arrangements.

Common examples of “preference” rights include:

• Priority on distributions (e.g. paid before ordinary shareholders in certain situations).
• Priority on liquidation or sale proceeds (e.g. “liquidation preference”).
• Fixed or cumulative dividends (in some structures).
• Conversion rights (e.g. can convert into ordinary shares).
• Redemption rights (in some cases, the company may buy them back on set terms).
• Protective voting or veto rights for major decisions.

If you’re issuing different classes of shares (for example, ordinary and preference), it’s worth checking that your governance framework supports it (including your Company Constitution if you have one, and shareholder arrangements) before you negotiate investor terms too far down the track.

Preference Shares Debt Or Equity: The Core Difference You Need To Understand

Let’s get really clear on the baseline definitions, because this is where most confusion starts.

What Makes Something “Equity”?

Equity is ownership in the company. If someone holds shares, they’re generally a shareholder (an owner), not a lender.

Equity investors usually:

• take on business risk (they can lose their investment),
• benefit if the company grows in value, and
• sit “behind” creditors if the company fails (even if they have preferences compared to other shareholders).

Preference shares are still shares. That’s why, from a company law perspective, they are generally treated as equity.

What Makes Something “Debt”?

Debt is a repayment obligation. A lender gives money to the business and expects it back, usually with interest, on set terms.

Debt usually involves:

• a legal obligation to repay principal,
• interest payments,
• default consequences, and
• priority ranking ahead of shareholders on insolvency (often backed by security).

So Why Do Preference Shares Sometimes Feel Like Debt?

The short version: some preference share terms are drafted to reduce investor risk and create “return certainty”. The more certainty and repayment-like features you build in, the more debt-like they can appear commercially (even if legally they’re still shares).

This is exactly why founders keep asking whether preference shares are debt or equity. They’re trying to work out what they’re really agreeing to.

As a practical risk check, if your “shares” include:

• a mandatory redemption date (or an investor right to force redemption),
• a fixed return that accrues regardless of company performance, or
• strong enforcement-like rights if the company can’t meet certain milestones,

…then you’re moving toward something that can feel closer to debt in economic effect. (That said, preference shareholders still generally aren’t creditors, and their rights still sit within the Companies Act framework for shares.)

What Terms Make Preference Shares Look More Like Debt?

Not all preference shares are the same. The rights attached can range from fairly standard “venture-style” preference shares through to structures that effectively behave like a repayment instrument.

Here are key terms that commonly drive the “debt vs equity” debate.

1. Redemption Rights (And Especially Mandatory Redemption)

Redemption means the company buys the shares back (often at a pre-agreed price or formula).

If redemption is:

• optional (e.g. the company may redeem if it chooses and can afford to), it’s generally less debt-like; but
• mandatory (e.g. the company must redeem by a set date), it can start resembling a debt repayment schedule.

In NZ, share buybacks and redemptions can be legally complex because there are solvency and procedural requirements under the Companies Act (including director resolutions and solvency certificates, depending on the structure). You don’t want to promise a redemption outcome your company may not legally (or financially) be able to deliver.

If your deal includes buyback mechanics, it’s often worth getting the structure checked alongside your Share Buyback Agreement approach (where relevant) so the commercial promise aligns with what your company can actually do in practice.

2. Fixed Or Cumulative Dividends

Some preference shares come with a right to dividends at a set rate (sometimes cumulative, meaning they “stack up” if not paid).

This can feel like “interest”, but there are important differences:

• dividends must be permitted under the Companies Act and are generally subject to solvency tests and director approval processes,
• they’re not always guaranteed to be paid on a timetable like interest is, and
• they don’t automatically turn the shareholder into a creditor.

That said, cumulative dividend structures can still create pressure on the business and materially affect founder outcomes in an exit.

3. Liquidation Preferences (Exit Waterfalls)

A liquidation preference usually gives preference shareholders priority to receive proceeds before ordinary shareholders when there’s:

• a liquidation/insolvency, and often
• a sale of the company or other major “liquidity event”.

This is one of the most common and most important preference rights.

Even though it’s not “debt”, it can function like downside protection in a way that reduces investor risk, similar to how secured debt reduces lender risk.

From a founder perspective, the key question is: what does the exit waterfall look like? For example, does the investor get:

• their money back first (1x preference), then everyone shares the remainder, or
• their money back and still participate with ordinary shareholders (participating preference shares)?

Those outcomes can be dramatically different in real dollars.

4. Conversion Rights (And Control Over Conversion)

Preference shares often convert to ordinary shares:

• automatically on a qualifying event (like an IPO), or
• at the investor’s option, or
• based on a valuation or anti-dilution formula.

Conversion rights are a classic “equity-style” feature, because they’re linked to upside and ownership rather than repayment.

But conversion terms can still create founder surprises, particularly where anti-dilution or special conversion ratios apply.

5. Investor Veto Rights And Board Control

Strictly speaking, veto and governance rights aren’t “debt-like”, but they can make preference shares feel less like passive ownership and more like having a powerful financial counterparty at the table.

Common veto matters include issuing new shares, taking on debt, selling key assets, changing budgets, or hiring senior executives.

If you’re giving any investor special rights, you’ll want them properly documented so your company can operate confidently and avoid shareholder disputes later. That’s where a tailored Shareholders Agreement is often essential (especially once you have more than one founder or investor).

How Are Preference Shares Treated In NZ Company Documents?

When you issue preference shares, the legal and practical outcome depends on how well your documents match the deal you think you’re doing.

For NZ startups and SMEs, preference share rights are commonly reflected across:

• The share terms for that class (sometimes attached as a schedule).
• Your constitution (if you have one) which may permit different share classes and set baseline rights.
• A shareholders agreement that covers governance, transfer restrictions, decision-making, and protections.
• Board and shareholder resolutions approving the issue and confirming the rights.

One common trap is having “investor term sheet language” that never properly makes it into the binding documents, or having inconsistent drafting across documents. That can lead to:

• confusion about what rights actually apply,
• disputes at the exact moment you need clarity (like an exit), and
• delays in future fundraising when new investors do due diligence.

If you’re raising money and locking in investor rights, it’s also common to document the upfront deal terms in a Term Sheet first. Just keep in mind that parts of a term sheet can be non-binding while other parts may be binding (like confidentiality and exclusivity), so it’s worth getting clarity before you sign.

Why The Debt vs Equity Question Matters For Startups And SMEs

Even if preference shares are “equity” in legal form, the debt-like features can create practical consequences that founders feel day-to-day.

1. Your Future Fundraising (And Cap Table Cleanliness)

New investors will look closely at existing preference share rights. If earlier investors have aggressive preferences, redemptions, or veto rights, later investors may:

• push back on valuation,
• require renegotiation of old terms, or
• walk away if the cap table is too messy.

Getting it right early can make later rounds smoother.

2. Sale Of Business Outcomes (Who Gets Paid First)

In an exit, preference rights can decide whether founders receive meaningful proceeds at all (especially in a modest sale where there isn’t a lot left after paying investors’ preferences and any company creditors). Preference shareholders generally sit behind creditors, even if they rank ahead of ordinary shareholders within the shareholder group.

If you’re building to sell one day, it’s smart to understand how different sale structures work, including the difference between share sales and asset sales. A Share Sale Agreement may come into play in a transaction, and preference rights can influence the approvals and payout mechanics.

3. Cashflow Pressure

Debt has obvious cashflow impacts (interest and repayments). Preference shares can also affect cashflow if they include:

• dividend expectations (to the extent dividends can lawfully be paid),
• redemption expectations (to the extent a buyback/redemption can be completed under the Companies Act), or
• milestone-based penalties that increase investor entitlements.

Even if the documents say “subject to solvency” or “at the directors’ discretion”, commercial expectations still matter. Misalignment here can lead to conflict.

4. Control And Decision-Making Speed

Preference shares can come with controls that slow down your ability to act quickly (which is often a startup’s biggest advantage).

That doesn’t mean you should avoid them. It just means you should be intentional about:

• which decisions require investor consent,
• what information rights you’re agreeing to, and
• how board appointments and voting thresholds work.

5. Accounting And Commercial Perception

Founders often ask whether preference shares “sit as debt” in accounts. The accounting treatment can be nuanced and depends on the specific features (especially any mandatory redemption or unavoidable payment obligations), and it may differ from the legal characterisation under company law.

Because accounting and tax treatment can affect how banks, investors, and partners view your financial position, it’s worth getting both legal and accounting advice where your preference share terms start to look more like a repayment obligation.

What Should You Do Before Issuing Preference Shares?

Preference shares can be a great tool to attract investment while still building a strong, scalable company. The key is to treat it as a major legal and commercial step (because it is).

Here’s a practical checklist to work through before you sign or issue anything.

1. Get Clear On The Commercial “Why”

Ask what the preference shares are trying to solve. For example:

• Are you giving investors downside protection so they’ll accept a higher valuation?
• Are you trying to avoid taking on debt and personal guarantees?
• Are you structuring rights to reflect different risk levels between investors?

If you can’t explain the “why” in one or two sentences, there’s a good chance the structure is more complex than it needs to be.

2. Map The Worst-Case And Best-Case Exit Waterfalls

Don’t just look at the valuation and investment amount.

Model what happens if you sell for:

• less than expected (a down exit),
• roughly what you hope (base case), and
• much more than expected (home run).

This is where founders often discover that “equity” can still mean “you might not see much of the exit proceeds” if preferences stack up.

3. Make Sure Your Company Can Legally Issue The Share Class

Before you promise rights to investors, check that your company’s setup can support it. This usually includes:

• whether your constitution (if any) permits the rights you’re offering (or whether you need to adopt or amend one),
• whether shareholder approvals are required, and
• whether you’ve properly documented share classes and rights.

If you’re tightening up governance at the same time (common in a first raise), it’s a good time to review your Company Set Up position and ensure your legal foundation matches your growth plans.

4. Put The Right Contracts In Place (And Keep Them Consistent)

Preference shares aren’t just a “one document” deal. Investors will expect their rights to be enforceable, and you’ll want clear rules so you can run the business without constant uncertainty.

Typically, that includes a properly drafted shareholders agreement and supporting resolutions and issue documentation. If the structure is more bespoke, you may also need specific variations or accession deeds for new parties.

5. Avoid DIY Templates For Anything That Affects Ownership Or Control

It’s tempting to grab a template online when you’re trying to close a round fast. But preference shares are one of those areas where small drafting choices can have huge consequences.

A clause that seems harmless (like a redemption right, or what counts as a “liquidity event”) can change founder outcomes dramatically. This is one of those “get it right from day one” moments.

Key Takeaways

• Preference shares are generally equity because they are shares that represent ownership, not a traditional loan repayment obligation.
• The question “are preference shares debt or equity?” comes up because some preference share rights (like redemption features and fixed-looking returns) can make them behave more like debt in practice.
• Key preference share terms to watch include redemption rights, fixed or cumulative dividends, liquidation preferences, conversion mechanics, and investor control/veto rights.
• Preference share rights should be consistently reflected across your share terms, constitution (if you have one), and a well-drafted shareholders agreement to reduce the risk of disputes and delays in future fundraising.
• Before issuing preference shares, model your exit waterfall outcomes and get advice so the structure supports growth without creating unexpected cashflow or control constraints (and consider accounting and tax implications where relevant).

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