Difference Between Equity shares and Preference shares

Companies require money to carry out their business operations or for the expansion of business. In short, money is the lifeline of any business and it can be difficult for the owners to meet all the cash requirements by themselves.

 

One of the methods of raising capital for businesses is by issuing shares of a company. A company divides its capital into small parts of equal value and each part is called a share. Each share of a company carries in itself a part of the ownership of a company.

 

It is a popular way of raising money for companies and the public to get a part in the ownership of the company and benefit mutually from the growth of the company. There are two types of shares:  Equity shares and Preference Shares.

 

 

What are Equity Shares

• Equity shares are securities issued under the company’s share capital which means that the amount raised by issuing equity shares is the company’s money.
• Equity shares are an important source of raising long-term capital and companies generally issue such shares when they require a huge amount of funds for a longer period of time.
• Equity shareholders are also called common shareholders as they do not have any preferential rights like preference shareholders.

 

 

What are Preference Shares

Preference shares means those shares that have a preferential right attached to them in terms of payments of dividends and in liquidation which are the primary advantages of preference shareholders over equity shareholders.

 

Preference shares are also called hybrid shares because they have both the features of debentures and equity shareholders. All funds raised by issuing preference shares are categorized under Preference share capital in the balance sheet. The primary use of preference share capital in the capital structure is for expansion purposes or carrying out daily business operations.

 

They have a fixed rate of dividends attached to them similar to that of debentures and in most cases, preference shareholders are paid dividends when the company is in a position to do so, the same as equity shareholders. That is why these shares are also called hybrid shares.

 

Preference shares are of different types and have varied characteristics. However, preference shareholders do not have voting rights so they do not have any control over the activities of the company.

 

Preference shares can be converted into equity shares given their types and also can be brought back by the companies if they wish to do so. Know in-depth about the features and types of preference shares.

 

 

What is the Difference between Preference Shares and Equity Shares?

The difference between equity shares and preference shares is prominent on these major points:

 

	Equity Shares	Preference Shares
Definition	Equity shares are common shares with no preference rights over other shareholders.	Preference Shares are shares that give preferential rights to its shareholders over dividends & in case of liquidation over equity shares.
Dividend Preference	Equity shareholders are given dividends after fulfilling all other external liabilities and dividends to payment to preference shareholders.	Preference shareholders are preferred over equity shareholders when it comes to dividend payment as they have a preferrential right of receiving dividends over equity shareholders whenever the company decide to give dividends.
Voting Rights	Equity shareholders are bestowed with the right to vote when it comes to participating in the decision-making process of a company giving them a certain degree of control on the management of a company.	Preference shareholders do not enjoy any such voting rights. Thus, they do not have any degree of control over the decision-makling process of a company.
Dividend Payment	Equity shareholders do not have a fixed rate of dividend and they receive dividends at the end from whatever is left after payment of all other obligations.	Preference shareholders receive a predetermined fixed rate irrespective of the quantum of profit incurred by the company.
Liquidation	In the event of liquidation, equity shareholders will get the last claim over the assets of the company after paying off external debts and preference shareholder's claim.	Preference shareholders will be preferred over equity shareholders in the event of liquidity and preference shareholders claim will be settled before equity shareholders.
Dividend Arrears	In case of non-payment of dividend in a particular year, the arrears of dividend is not transferred to the next year	In the case of preference shareholders, the arrears of dividends are transferred to the subsequent years, if they are cummulative preference shareholders.
Convertibility	Equity shares cannot be converted into preference shares under any circumstances.	Preference shares can be converted into equity shares, if they are convertible preference shares.
Risk	Equity shareholders are at higher risk as their dividend payment depends on the profits incurred by a company and are paid after meeting all other obligations of the company.	Preference shareholders are at a lower risk in comparison to equity shareholders as they are paid a fixed rate of dividend every year and get a preferrence over equity shareholders in respect to dividend payments and claim over over assets in the event of liquidation.
Cost	Equity shares are priced lower in comparison to preference shares which makes them a preferred option for small investors.	Preference shares usually come at a higher price which makes them more suitable for medium and large investors.
Redemption of Shares	Equity Shares cannot be redeemed by the company until the company is in existence.	Preference shares can be redeemed by the company after a fixed period of time or after the completion of its maturity period.

 

 

Features of Equity Shares

1). Primary Risk Bearers: Equity shareholders bear the maximum risk in a company as compared to other stakeholders in the company. In case the company suffers losses or inadequate profits, equity shareholders will be the primary loss bearers as they receive dividends only after paying off outsiders and preference shareholders.

In case of liquidation also, equity shareholders will be paid their share once after all the other obligations such as loans to outsiders, and payments to preference shareholders are made.

 

2). Claim over Residual Income: The equity shareholders have a claim over the leftover income of the company only. They get a share of the income left after satisfying claims of all creditors, outsiders, and preference shareholders.

In case of losses or if the profits get exhausted, in paying off the liabilities, equity shareholders are likely to receive dividends in such a case.

 

3). Basis for Loan: Equity shares are the basis on which loans can be taken or given. The higher the equity share capital of a company, the more will be its credibility. The increase in the equity share capital of a company enhances the confidence of creditors in the company.

 

4). Control: Equity shareholders control the decision-making process of a company. The equity shareholders possess voting rights. The equity shareholders can cast vote to select the board of directors who control and manage the affairs of the company.

 

5). Higher profits: The rate of interest for debenture holders and the rate of dividends for preference shareholders are fixed. At the time of profit, debenture holders and preference shareholders get fixed income only but equity shareholders can get higher profits.

 

6). Pre-emptive Right: According to this right, whenever a company is planning to issue new equity shares, it must offer the shares to existing shareholders first. If existing shareholders refuse to buy the new issue, then the company shall offer these shares to the general public.

 

 

Advantages of Equity shares

Given its features, the advantages of equity shares over preference shares are:

• Unlimited Profits: Preference shareholders get a fixed dividend whereas equity shares get a dividend out of what is left after paying off all other obligations.
• In cases, where the profits of a company are exorbitant in a particular year, then in, such cases equity shares may get huge dividends in that particular year.
• Control over the management: Equity shareholders get voting rights which gives them a degree of control over the decision-making process of a company.

If you are a big shareholder in a company, then you have a greater degree of control over the management of that company.

 

 

Types of Equity Shares Capital

Equity shares are also called common shares as they do not have any types and preferential rights as such but there are types of equity share capital that can be considered as types of equity shares.

Equity Share capital means the total amount invested by investors in return for equity shares of the company.

The types of equity share capital are as follows:

• Authorized Share Capital
• Issued Share Capital
• Subscribed Share Capital
• Paid-up Share Capital
• Called-up Share Capital
• Rights Issue
• Sweat Equity SharesBonus Shares

 

 

Advantages of Preference Shares

• Dividend payments: Preference shareholders are preferred over equity shareholders whenever the company decides to pay dividends to its shareholders.
• Preference shareholders get a fixed dividend every year, irrespective of the profits earned by the company whenever a company decides to pay dividends to its shareholders.    
• Claim over Assets: Preference shareholders have a right to claim their share over equity shareholders in the event of liquidation.
• In the case of liquidation, when a company sells off its assets, they pay off the preference shareholders their share in the company’s capital fund over equity shareholders.

 

 

Types of Preference Shares

• Cumulative Preference Shares
• Non-Cumulative Preference Shares
• Convertible Preference Shares
• Non-Convertible Preference Shares
• Redeemable Preference Shares
• Non-Redeemable Preference Shares
• Callable Preference Shares
• Adjustable-Rate Preference Shares
• Convertible Preference Shares

Know in-depth about the features and types of preference shares.

Conclusion

Companies issue both equity and preference shares depending on their requirements and cost. Both methods of raising come with their pros and cons.

Equity investors are more focused on the growth of the company so that they could make capital gains as their wealth increases with the share price of a company whereas preference shareholders are more concerned about regular dividend payments.

Companies issue preference shares for the mid and long-term depending on their need whereas equity shares are issued for the long term. Therefore investors should buy these shares accordingly depending on their requirements and style of investing. You can invest in both these types of shares by simply opening a Demat account. Know how to open a Demat account and start investing in the share market.

 

 

Frequently Asked Questions (FAQ)

Q ue 1. What are sweat equity shares?

Ans.  According to 2(88) of the Companies Act, 2013 sweat equity shares are shares of the company issued to a company's employees either by discount or consideration other than cash.

Sweat equity shares are offered to select employees and directors of a company for their:

1). Extraordinary contribution and hard work in completion of a project.

2). Technical know-how and expertise in the area of a business.

3). Value addition made to business or contribution towards gaining intellectual property rights.

 

Employees are an integral part of an organization and offering sweat equity shares to performing employees boosts employees morale and allows employees/directors to participate in a part of the company’s profits as a return on their investment.

 

Que 2. How to buy preference shares?

Ans. Preference shares can be alternatives to equity shares and can be bought from both primary and secondary markets. If fresh preference shares are being issued by the company for the first time then it can be bought from the primary markets in the form of IPO and FPO.

Whereas on the other hand, if the shares are already listed in the market, they can be bought from the secondary markets or stock exchanges given that you have a demat account.

 

Que 3. What is redemption of preference shares?

Ans. Redemption of preference shares is the process of repaying preference shareholders' capital or the amount initially invested. The date of the redemption is called the maturity date, and it is usually mentioned in the preference share certificate.

Other than that, preference shares can also be redeemed at any time when the issuing company seems right or when the shareholders want.