Table of Contents
ToggleEvery 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.
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.
Equity shares are categorised into several types, and the following are some of them.
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.
The following are the different types of preference shares.
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:
Basis of difference | Equity shares | Preference shares |
Definition | Equity shares are units that represent ownership of a company. | Preference shares are units that hold a preferential right over dividend and capital repayment. |
Types | A company issues only one type of equity share, which is the ordinary stock of the company. | There are eight different types of preference shares, namely convertible, non-convertible, cumulative, non-cumulative, participating, non-participating, redeemable, and irredeemable. |
Dividend rate | The rate of dividend depends on the profit earned by the company and is not fixed. | The rate of dividend is fixed for preference shares. |
Dividend payment | The dividend is paid only when the company earns profits and after it pays its preference shareholders. | The dividend is paid when the company earns a profit, and in some cases, it is paid even when it earns a loss. |
Arrears of dividend | Equity shareholders are not entitled to avail arrears of dividends. | Preference shareholders can avail dividend arrears along with the current year’s dividend. |
Bonus shares | Equity shareholders can receive bonus shares against existing equity shares. | Preference shareholders cannot receive bonus shares. |
Voting rights | These shares have voting rights. | These shares do not have voting rights. |
Role in management | Can participate in the company’s management. | Cannot participate in the company’s management. |
Risk | Have higher risk compared to preference shareholders. | Have lower risk as the payout is fixed. |
Convertibility | It cannot be converted to preference shares. | Some preference shares can be converted into equity shares. |
Redemption | These shares cannot be redeemed by the company. | These shares can be redeemed by the company. |
Financing | They are used by companies to finance long-term plans. | They are used by companies to finance short-term plans. |
Nominal value of shares | The nominal value of equity shares is low, making it accessible to all investors. | The nominal value of preference shares is high, making them accessible only to medium and large investors. |
Market value of shares | The market value of equity shares fluctuates based on market demand and supply. | The market value of preference shares does not fluctuate. |
Mandate of issue | All companies need to issue equity shares. | It is not mandatory for companies to issue preference shares. |
Financial burden to companies | Companies do not have the burden to pay dividends or capital to equity shareholders. | Companies are required to pay dividends and capital to preference shareholders. |
Types of investors | Equity shares suit investors with a high-risk tolerance. | Preference shares suit investors with low-risk tolerance. |
Liquidity | These shares are very liquid as they trade on the stock exchange. | These shares aren’t liquid, but the company buys them back after a certain period of time. |
Bankruptcy | During bankruptcy, equity shareholders may or may not get their capital back. | Preference shareholders are paid after the creditors are paid their loans and hence have a preference over equity shareholders. |
Liquidation | Upon liquidation, equity shareholders are paid after creditors and preference shareholders are paid. | Preference shareholders are paid after creditors but before equity shareholders. |
Now you the difference between equity share and preference share, let’s learn some similarities between equity and preference shares.
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.
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.
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.
There are eight different types of preference shares, namely convertible, non-convertible, cumulative, non-cumulative, participating, non-participating, redeemable, and irredeemable.
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.
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.
Powerd by Issued by
Check credit limit in 30 sec.