HANSE OIL Profit Participation Shares
Profit participation certificates are debt obligations which also embody certain rights which are normally reserved only for shareholders of a company. For this reason, they are often regarded as “hybrid” instruments which occupy a position between bonds and shares.
These instruments pay a fixed rate of “interest” which is, however, conditional upon the company generating profits available for distribution. Should the company’s profit not be sufficient to pay the stipulated return, then – depending on the terms and conditions of the profit participation certificate – this may or may not be accrued for payment in future years. Distributions may also depend upon other financial criteria besides reported net income, such as dividend payments to shareholders.
In contrast to shareholders, holders of profit participation certificates do not have the right to vote in shareholder meetings. The company’s financial obligations to them are, in addition, generally subordinated to its other claimants. Although the instruments have, in some way, the legal character of an interest-paying debt obligation, profit participation certificates are included in the company’s accounts as equity capital because their holders bear risks associated with equity ownership.
Because these instruments carry greater risks than bonds, the returns which they pay is generally higher than that of comparable bonds, sometimes by as much as two per cent, or even more.
A particular characteristic of trading in profit participation certificates which is important for investors to understand is that, unlike bonds, accrued interest is not paid separately but is already included in the price. Their market price therefore abruptly drops by the amount of the annual “interest” payment on the relevant record. This procedure provides certain tax advantages which investors may use to their benefit, in addition to the higher returns which these instruments generally pay.
Because profit participation certificates may vary greatly in their features and characteristics, it is essential that all relevant information, including the terms and conditions of the instrument in question, is read and understood before any investment is made.