Key Difference Between Equity Share and Preference Share

Every company either uses its own money or outsiders’ money to fund its operations. The own funds are usually known as shareholder’s capital, whereas the outsiders’ money is known as debt or borrowed capital. Within shareholder’s capital, there are two different types known as equity and preference capital. Although both are quite similar, they differ in terms of dividend payment and voting rights. This article explains the key difference between equity share and preference share.

What Are Equity Shares?

Equity shares, also known as ordinary shares, are issued by companies by diluting their ownership. So, if you own equity shares of a company, you are part owner of it. Equity shareholders have voting rights, which means they get to participate in the important decisions of the company. Moreover, they are also entitled to get a share in profits through dividends.

The company pays dividends to equity shareholders every year. However, the amount of dividends varies based on the profit the company earns. The higher the profit, the higher would be the dividend. However, you will not receive the entire profit. You are only entitled to receive the surplus after the company pays off all its responsibilities, such as preference dividends.

Equity shares are non-redeemable, which means the company will not buy them back after a certain period of time. Hence they act as a source of long-term capital for the company. However, when the company is winding down its operations, equity shareholders are entitled to receive the surplus and also have a claim on the assets.

You can trade in equity shares through the stock exchange and hold them in your demat account. Apart from receiving dividends, you will also benefit from capital appreciation, which is an increase in the price of the share over a period of time.

Apart from being a great source of long-term wealth, equity shares also help in acquiring credit. Both company and shareholders can take a loan against the shares of the company to fund the deficit.

Types of Equity Shares

Equity shares are categorised into several types, and the following are some of them.

1. Authorised share capital: It is the maximum amount of share capital a company can use. The authorised share capital can be altered from time to time by amending the memorandum of association (MoA) of the company.
2. Issued share capital: The company doesn’t issue the entire shares to the public. It only issues part of it, which is known as issued share capital. The rest is held by the promoters of the company.
3. Subscribed share capital: Subscribed share capital is a subset of issues share capital. It is part of the issued capital, which is subscribed by the shareholders.
4. Paid-up capital: It is part of the subscribed share capital, which is paid by the shareholders.
5. Sweat equity shares: Equity shares issued to compensate the efforts of employees or directors for their hard work are sweat equity shares.
6. Bonus shares: A company pays dividends in the form of cash or shares. Shares which a company issues to its shareholders in the form of dividends are bonus shares.
7. Rights shares: Shares that have certain rights attached to them are rights shares. These are issued by the company to safeguard the interest of existing shareholders.

What Are Preference Shares?

A preference share is a type of stock that grants the holder a fixed dividend, ensuring that they receive their dividend payments before ordinary shareholders. The priority of dividend payments for preference shareholders takes precedence over the distribution of dividends to common shareholders. However, they do not get voting rights and hence cannot participate in the company’s decisions.

Preference shareholders are entitled to a fixed dividend every year. Even if a company makes less profit, they have to pay the preference shareholders a fixed premium. However, if a company loses, it need not pay a dividend. If a company makes a profit and doesn’t pay a dividend in a year, it must pay the preference shareholders their dividend later during the year.

During liquidation, preference shareholders have a right to the assets after the creditors of the company are paid off. Hence this puts them second in the ranks of preference after creditors but before equity shareholders. But they do not get voting rights like equity shareholders and do not receive any bonuses or rights issues.

A company can recall back the preference shares anytime by paying back the money to preference shareholders. Alternatively, they can also be converted into equity shares by the company.

Types of Preference Shares

The following are the different types of preference shares.

1. Convertible preference shares: Preference shares that can be converted into equity shares at a fixed rate are convertible preference shares.
2. Non-convertible preference shares: The shares that cannot be converted into equity shares are non-convertible preference shares.
3. Cumulative preference shares: Preference shares that are entitled to receive cumulative dividends from the company even when the company is not profitable are cumulative preference shares. So, when the business is not profitable, the dividends will be reported as arrears and will be paid to the cumulative preference shareholders when the company turns profitable.
4. Non-cumulative preference shares: Preference shares that are not entitled to receive dividends from the company when it is not profitable are non-cumulative preference shares. So, when the company is not profitable, non-cumulative preference shareholders do not receive dividends and cannot claim them in the future.
5. Redeemable preference shares: The shares that can be redeemed (exchanged for cash) by the company during its lifetime are redeemable preference shares.
6. Irredeemable preference shares: The shares that cannot be redeemed by the company during its lifetime are irredeemable preference shares.
7. Participating preference shares: Preference shares that carry a right to participate in the extra surplus of the company during liquidation are known as participating preference shares.
8. Non-participating preference shares: Preference shares that do not carry a right to participate in extra surplus or earnings of a company during liquidation are known as non-participating preference shares.

What’s the Difference Between Equity Share and Preference Share?

Equity shares are ordinary shares of a company that represent company ownership. Whereas preference shares have preferred privileges in terms of dividend payout and capital return.

Let’s understand the difference between equity share and preference share through the comparison table:

Equity Share vs Preference Share

Similarities Between Equity Shares and Preference Shares

Now you the difference between equity share and preference share, let’s learn some similarities between equity and preference shares.

• Both types of shares represent a part of the ownership of the company.
• Equity and preference shares give returns in the form of dividends or capital appreciation.
• They are traded on the stock exchange.
• Both are defined under section 85 of the Companies Act 1956.

Conclusion

Both equity and preference shares are investment options that you must carefully analyse. Each of them has their own advantages and risks. Hence before choosing one, make sure you assess your goals, risk tolerance, and horizon. Additionally, you must analyse a company’s fundamentals, such as revenue and profit growth, debt, return on equity, and other ratios, to find the best company to invest in.

Frequently Asked Questions

1. What is preference share in simple words?

   Preference shares represent part ownership of a company. So, if you are holding preference shares of the company, you have ownership of the company to the extent of the shares you hold. Moreover, preference shares have an additional right to get dividends and have a claim on assets before equity shareholders.

2. What is the difference between equity shares and CCPS?

   CCPS or compulsory convertible preference shares can be converted to equity shares after a certain period. They also hold the right to receive dividends before equity shareholders. Equity shares, on the other hand, are not converted into preference shares. They represent part ownership of the company and are entitled to have voting rights.

3. What is the difference between types of preference shares?

   There are eight different types of preference shares, namely convertible, non-convertible, cumulative, non-cumulative, participating, non-participating, redeemable, and irredeemable.

4. Why are preference shares called so?

   Preference shares hold the right or preference to receive dividends over equity shareholders. Moreover, they have a claim on assets. This means that if a company liquidates its assets, preference shareholders can claim the money before equity shareholders.

5. Who can buy preference shares?

   Individuals or institutions who have a low-risk tolerance and high capital can consider investing in preference shares. This is because preference shares somewhat pay predictable returns and have a high ticket value, making them suitable for risk-averse medium and large investors.