Difference Between Equity Share and Preference Share

Difference Between Equity Share and Preference Share

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Jaya
Jaya Sharma
Assistant Manager - Content
Updated on Jul 3, 2024 19:18 IST

Equity shares offer voting rights to the shareholder with higher profits but these are riskier and fluctuate often. On the other hand, preference shares do not offer any voting rights and have lower returns but are stable fixed dividends

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There are different types of securities available in the capital market. Equity and preference shares are the commonly traded securities that give good returns to investors. Both are defined by the section 85 of Indian Companies Act 1956. The main difference between equity share and preference share is in what they offer. Equity shares provide investors with partial ownership whereas preference share offer fixed dividends to shareholders. In this article, we will learn the difference between equity share and preference share. We will also learn the types, advantages and features of these shares. 

Table of Contents

Difference Between Equity Share and Preference Share

Let us distinguish between equity shares and preference shares:

Difference Equity Shares Preference Shares
Significance Represent ownership in the company Represent claim over company’s profits and assets
Returns  Capital appreciation Regular dividend income
Payment of Dividend Least priority High priority
Dividend Rate Varies based on the earnings The rate is fixed
Issue Mandate Company needs to issue equity share capital There is no fixed requirement to issue preference share capital
Bonus Shares Eligible Not eligible
Voting Rights Yes No
Participation in Managerial Decisions Yes No
Redeemable No Yes
Conversion Not possible Possible
Compulsion Companies must issue equity share capital Optional to issue
Investment Lower investment High investment
Risk appetite High risk Low risk

What is equity share?

Equity shares represent a part of the company. Companies issue these shares to raise capital for their business operations. Anyone who purchases these shares gets a percentage of ownership in the firm. Equity shareholders have a symbiotic relationship with the company. Not only the shareholders are benefiting through profit but also the company is getting capital from shareholders.  

Also known as common shares, these stocks are traded on a public exchange. Every share gives the shareholder the right to one vote at shareholders meeting. Ordinary shareholders do not guarantee arrears of dividends. These shares are issued by the company for raising funds to fulfil long term expenses.

Features of Equity Shares

The equity shares have the following features:

  1. These shareholders enjoy voting rights. They also have a say in the business decisions of the company.
  2. They do receive dividends however the payout is not guaranteed and may vary based on the business performance.
  3. Equity shareholders do not get refunds from the company. To regain their money, investors can start investing in either trade the shares or wait till liquidation of the company. 
  4. They have limited liability which means any loss that the company bears does not significantly affect equity shareholders except for the decrease in their price. 

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Types of Equity Shares

  1. Bonus shares: These are the add-on shares that are part of the company’s accumulated earnings. Company gives out these shares free of cost to its shareholders. 
  2. Rights shares: These are issues of shares that a company offers at discounted price to its existing shareholders. Company’s shareholders have to fulfill the minimum criteria for the subscription. 
  3. Sweat equity: The company issues these shares to its employees and directors at discount for non-cash consideration. 
  4. Employee stock options: It is an equity compensation that company grants to its employees and executives. The company offers derivative options on stocks rather than offering shares on stocks directly.
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What is preference share?

Companies issue these types of shares for raising capital. Unlike ordinary equity shares, such shareholders do not get the voting or membership rights. Preference shareholders get a certain amount of profit and bonus are returns based on the annual profits of the company. They also get dividends and preference in capital repayment in case of liquidation of the company. 

When a company gets liquidated, then preference shareholders have the claim to the company’s assets. They will receive shares in assets in an order depending on the rights given to them in security agreements. These shares have higher priority than equity shares but lower priority than fixed-income securities.

Features of Preference Share

Following are the features of a preference share:

  1. These shareholders are preferred by the company while paying out dividends or sharing assets at the time of liquidation.
  2. The company has the ability to repurchase its preferred stocks on specified dates. 
  3. These shares can be easily converted into equity shares either through the approval of the Board of directors or after a specific date.

Types of Preference Shares

  1. Convertible Preference Shares: These are the preference shares that can be converted to either an agreed number of ordinary shares or into cash.
  2. Non-Convertible Preference Shares: These shares cannot be converted into equity shares, but they can be redeemed at the expiry of the tenure.
  3. Redeemable Preference Shares: The issuer of these shares have the right to redeem shares within 20 years of issuance at a predetermined price that has been mentioned in the prospectus at issuance time.  
  4. Irredeemable Preference Shares: These shares cannot be redeemed by the company. In India, companies are not allowed to issue these shares.
  5. Cumulative Preference Shares: These shares have all the benefits and features of ordinary preference shares, including preference in dividend payment, entitlement to higher dividends and payments during liquidation.
  6. Non-Cumulative Preference Shares: Through these shares, shareholders get only a fixed amount of dividends every year from the net profit of a company.

Similarities Between Equity Shares and Preference Shares

Equity shares and preference shares are shares issued by companies, but they cater to different investor preferences and risk appetites. While there are many differences, they do have some similarities:

  1. Ownership in the Company: Both equity and preference shareholders are considered part-owners of the company. They hold a stake in the company's assets and earnings.
  2. Capital Raising Instruments: Both are used by companies to raise capital. Issuing shares is a common method for companies to obtain funds without needing to take on debt.
  3. Potential for Capital Appreciation: Both types of shares can potentially appreciate in value, offering the opportunity for capital gains. This appreciation is dependent on the company’s performance and market conditions.
  4. Tradable on Stock Exchanges: Both equity and preference shares are typically tradable on stock exchanges. These provide liquidity and ease of buying and selling for investors.
  5. Rights to Company Information: Shareholders of both types typically have the right to receive information about the company, such as annual reports and details about significant corporate actions.
  6. Subject to Market Risks: The value of both equity and preference shares can fluctuate based on market conditions, making them subject to similar market risks.
  7. Potential Dividend Income: Both types of shares may provide dividend income, although the nature and priority of these dividends differ between equity and preference shares.
  8. Contribution to Company’s Equity: Both equity shares and preference shares contribute to the company’s equity capital.

Conclusion

While equity shares and preference shares differ in several aspects, both are part of company-owned capital. Once you learn the difference between equity shares and preference shares, you can decide on shares that you want to include in your investment portfolio.

FAQs

How do dividend rights differ between the two?

Preference shareholders receive dividends before equity shareholders. However, the dividend rate for preference shares is fixed, while equity shareholders receive dividends based on the company's profits.

Do both types of shares have voting rights?

Typically, equity shareholders have voting rights, while preference shareholders have limited or no voting rights, unless their dividends are unpaid.

Which type of share has a higher claim on assets during liquidation?

During liquidation, preference shareholders have a higher claim on the company's assets and earnings than equity shareholders.

Can preference shares be converted into equity shares?

Some preference shares, known as convertible preference shares, are convertible into equity shares after a specified period.

What is the difference between equity shares and preference shares and debentures?

All three are types of financial instruments that are used by companies for raising capital. Debentures are purely debt instruments that have the lowest risk amongst these three but do not offer any ownership or voting rights. Preference shares are hybrid in nature that offer fixed dividend with either limited or no voting rigts. Equity share offer ownership, voting rights and high returns but with risk.

About the Author
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Jaya Sharma
Assistant Manager - Content

Jaya is a writer with an experience of over 5 years in content creation and marketing. Her writing style is versatile since she likes to write as per the requirement of the domain. She has worked on Technology, Fina... Read Full Bio