Difference Between Preference Shares and Equity Shares

Table of Contents

Equity shares indicate a company’s ownership. While preference shares have preferential access to the company’s assets and income. The main distinction between equity and preference shares is also in regard to voting rights, ownership of the company’s assets, and dividends. Equity shareholders have the right to vote, while preference shareholders have a right to the company’s assets and profits before equity shareholders do.

Equity Shares

A company dilutes its ownership by issuing equity shares in order to raise money. To acquire partial ownership of the company, investors might purchase equity share units. Investors will become shareholders in the company and contribute to its total capital by purchasing equity shares. Equity shareholders are the company’s owners to the extent of the number of shares they own.

Through equity investing, investors benefit from capital appreciation and dividends. Equity owners receive financial benefits as well as voting rights in key company decisions. Equity shares are a popular investment option for many investors. Equity shares represent a fractional stake in the company. Equity stockholders are therefore regarded as part of the ownership. Through an initial public offering (IPO), equity shares are first made available to the public. Equity shares trade on the stock market after being listed.

Equity shareholders receive the profits a company makes. The majority of well-known, large-cap corporations give their shareholders dividends and bonuses. The face value or book value of an equity share represents its value. The price of a company’s shares will generally increase as more individuals purchase them. While prices will decrease if more individuals sell, The prices are set by supply and demand when the shares begin trading on the exchange, though. Investors want to invest in a firm if they believe that its growth prospects are favourable so that they can benefit from capital growth. In a similar vein, investors would seek to sell their holdings.

Features of Equity Shares

Some of the features of equity shares are as follows:

Permanent Shares: Equity shares are permanent by nature. Shares are a company’s long-term assets. and only get returned when the company winds up.

Significant Returns: Equity shares have the potential to provide stockholders with sizeable returns. However, these are high-risk investments. Equity shares are therefore very volatile. Price changes can be abrupt and are influenced by a variety of internal and external factors. Therefore, only investors with sufficient risk tolerance levels may consider investing in these.

Dividends: Profits from a company are divided among equity shareholders. In other words, a company can use its yearly profits to pay dividends to its shareholders. A company is not required to pay out dividends, though. A company can decide not to pay dividends to its shareholders if it doesn’t generate enough cash flow or earn good profits.

Voting Rights: Most equity stockholders have voting rights. This enables them to decide who will manage the company. Selecting capable management helps the company increase its yearly turnover. Investors may therefore see an increase in their average dividend income.

Additional Profits: Equity shareholders are eligible for additional profits a company makes. It, in turn, increases the wealth of the investor.

Liquidity: Equity shares generally have a high level of liquidity. The shares are traded on stock markets. The share is therefore available for purchase and sale at any moment during trading hours. Therefore, one need not be concerned about selling their stock.

Limited Liability: Losses a company makes doesn’t affect the ordinary shareholders. In other words, the shareholders are not responsible for the debt obligations of the company. The stock prices dropping is the only effect. The return on investment for a shareholder will be impacted by this.

Preference Shares

When it comes to sharing in the company’s profits, preference shareholders get special treatment. They are therefore a good choice for investors looking for consistent payouts. Due to their sheer variety and alternatives, these shares are attractive to a broad range of investors.

Preference shares, or preferred stock, represent ownership in a company. Shareholders who hold preference shares have preference over common shareholders for assets and profits. In addition, in the event of bankruptcy, preferred shareholders gain priority over common shareholders in receiving the company’s assets. A company generally issues preference shares to raise money. This becomes part of the preference share capital. Dividends are paid to preference shareholders before equity stockholders. There are several preference shares that are qualified to receive dividends in arrears. Furthermore, converting these shares to equity shares is simple.

Preference shareholders do not have voting rights like equity shareholders while having the first claim to the company’s earnings. These shares are preferred by many long-term investors seeking consistent income because the dividends are higher than those received by equity shareholders.

Features of Preference Shares

The following are a few key features:

Preference: Preference shareholders have advantages over common shareholders, as the term implies. They are given priority in the company’s distribution of dividends.

Voting Rights: Unlike equity shareholders, preference shareholders do not have voting rights.

Dividends Pay-outs: Dividends are paid to preference shareholders on specific dates.

Conversion: These shares are easily convertible to equity shares. After a certain date, some shares may be converted to common stock. While the conversion of some shares requires prior authorization and consent from the board of directors.

Liquidation: Preference shareholders are entitled to the company’s assets in the event of bankruptcy or liquidation.

Callability: On specific dates, the company may repurchase the preferred stock.

Difference Between Equity Shares and Preference Shares

Parameter	Equity Share	Preference Share
Definition	Equity shares represent a company’s ownership.	Shareholders with a preference have a claim to the company’s assets and profits.
Dividend payout	Payments to equity owners are paid only after dividends to preference shareholders.	The priority for dividend payments goes to preference shareholders.
Rate of dividend	The rate varies based on earnings.	The rate of the dividend is fixed.
Bonus shares	Equity shareholders are eligible to receive bonus shares against their existing holdings.	Preference shareholders do not receive any bonus shares against their holdings.
Capital repayment	It is repaid at the end.	It is repaid before equity shares
Voting rights	The shares have voting rights.	Voting rights are absent from preferential shares.
Role in management	An equity share comes with the power to participate in the company’s management.	Preference share does not extend management rights.
Convertibility	Equity shares cannot be converted.	Preference shares can be converted to equity shares
Arrears of Dividend	Equity shareholders do not receive arrears of dividends.	Certain types of preference shareholders are eligible for arrears of dividends.
Types	Ordinary shares, bonus shares, rights shares, sweat equity, and employee stock options.	Convertible, Non-Convertible, Redeemable, Irredeemable, Participating, Non-Participating, Cumulative, Non-Cumulative, Preference Share with a Callable Option and Adjustable Preference Shares

Dividend

Dividends are the amounts distributed to a company’s shareholders. Companies utilize it as a method of distributing their profits to their shareholders. Dividends are paid to shareholders by mature companies with steady earnings over the past few years. Along with that, consistent dividend payments boost investor trust in the company. Furthermore, these companies generally have higher share prices. It is distributed in the form of additional stock or cash per share. Dividends are also taxed in India.

Investors generally get dividend payments from established companies that have generated consistent profits over many years. They do this to draw in investors and raise the stock’s value. Companies also distribute dividends to investors to reassure them of their financial stability.

Companies distribute dividends because investors view them as a favourable indicator of management’s objectives. Regular dividend payments frequently boost investors’ confidence. It conveys to them information about the company’s potential for the future. Such companies are frequently chosen by investors seeking a steady income. Consequently, the demand for that stock may rise. Consequently, this also raises the company’s share price.

Conclusion

Preference shares and equity are two popular investment options on the market. However, because of their distinct distinctions, the two are favoured by various investors with various financial objectives.

Frequently Asked Questions (FAQs)

What are the different types of equity shares?

In order to raise money, businesses issue these shares to the public. These funds are used for the expansion of a company. Equity shares are a long-term source of funding for companies because they are not redeemable. The corporation retains ownership of the shares throughout and distributes them in the case of a wind-up. Equity shareholders are actually a company’s risk bearers because they are entitled to the residual shares following liquidation. In actuality, it is also the root of the distinction between equity share and preference share. In addition to having the ability to vote, equity shares also give their owners the right to claim profits and company assets. The following are a few types of equity shares:

- Authorized share capital: It is the maximum limit of capital that a company can use.

- Issued capital: This represents the total number of shares that the company has issued to its shareholders.

- Subscribed share capital: Amount of shares subscribed by the shareholders

- Paid-up capital: It is a part of subscribed capital, which includes the actual paid-up amount by shareholders.

- Right shares: This share comes with various privileges that are connected to company shares. These shares are being issued to safeguard the interests of current shareholders.

- Bonus shares: Shares that are issued to shareholders in form of dividends are bonus shares

- Sweat equity shares: Sweat equity shares are shares that are offered to reward employees or directors for their work.

What are the different types of preference shares?

The capital that a company raises through the issuance of preference shares is termed preference share capital. In addition to a fixed dividend rate, these shares also have a preferential right to profits and assets following liquidation.Following are the different types of preference shares:

- Convertible preference shares: Convertible preference shareholders can convert their preferred stocks to common stocks. These shares are chosen by investors who want to gain from rising common share prices as well as preferred dividends. As a result, there are two benefits: assured profits from preferred dividends and the chance to increase gains as the price of common shares increases. According to the memorandum, this conversion is permitted within a specific time frame.

- Non-convertible preference shares: Non-convertible preference shareholders are not permitted to convert their shares into equity stocks.

- Redeemable preference shares: Shares that are redeemable allow the company the option to repurchase them from shareholders at a certain time or with prior notice. The stock may be bought back by the company for internal purposes. Such a repurchase has a specified price.

- Irredeemable preference shares: Shares that are irredeemable can only be redeemed when the company goes into liquidation or winds up its operations.

- Participating preference shares: In addition to the preference dividend, participating preference shareholders also receive the additional dividend. In other words, the company give participating shareholders a bonus dividend. Typically, the additional rate is fixed. These shareholders also have claims to the company’s excess assets during a winding down or liquidation.

- Non-participating preference shares: Non-participating preference shareholders receive only set dividends and are not entitled to surplus profits. The extra profits go to the common stockholders.

- Cumulative preference shares: The ability to receive dividends in arrears are provided by cumulative shares. In other words, a company’s financial situation may occasionally make it impossible for it to distribute dividends to its stockholders. Common shareholders cannot receive dividends until preference stockholders are compensated. The company decides to pay cumulative dividends the following year in such a situation. The cumulative preferred stockholders are sometimes granted interest earned by stockholders on arrear dividends.

- Non-cumulative preference shares: Non-cumulative preference stockholders are ineligible for arrears dividends. They are only qualified for dividends from the current year’s profit. In other words, shareholders cannot make a claim for unpaid dividends in the future if a company loses money or decides not to pay dividends in a given year. Therefore, there will be no dividend paid to stockholders for that year.

- Preference share with a callable option: The company that offers callable option shares has the right to call in or buy back the stocks at a certain price on a specific date. The prospectus contains information about the call price, the deadline by which shares may be called, and the call premium.

- Adjustable preference shares: Dividend rates for adjustable preference shareholders are dynamic. The rate is based on the market’s current interest rates. As a result, the dividend rates are volatile.

What are the major differences between equity and preference shares?

Major differences between equity and preference shares

Preference shares can be redeemed after a specific time period while equity shares cannot.

Equity shares have voting rights in the company, whereas preference shareholders have preferential rights.

Preference shareholders have preference over equity shareholders in the event that a company is closed when it comes to the distribution of capital and profits.

The annual dividend is paid to preference shareholders first, followed by equity owners.

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