Difference Between Preference Shares and Equity Shares

If you have heard of the share market you must be familiar with the word “shares”. However, did you know that there are various types of shares? In this article, we discuss the various types of equity shares and the difference between equity shares and preference shares. 

Before we jump into that, let us first understand what equity shares and preference shares are.

Any share, irrespective of whether it is a preference share or equity, is the stake or the ownership composition you have in a company. These shares can often be liquidated into real cash for a price depending on the market forces at the sale. 

There are broadly two types of shares by which a company can raise its share capital – Equity shares and Preference shares. 

What is a preference share? 

Preference shares, as the name suggests, offer a slight preference over normal shares. Not only do preference shareholders get priority treatment over normal shareholders while settling a company’s assets, but they also get a fixed rate of dividend, and have a right in a company’s revenue share and gains. 

Preference shares can be purchased through the primary market if they are listed on the stock exchange, or via private transactions that usually have a minimum costing size of INR 10,00,000. 

While preference shares get priority over normal equities, they have certain downsides too:

• Usually, preference shareholders don’t have voting rights and therefore no right to decide the company’s course of action.
• No right or claim on bonus shares. 

In many ways, preference shares resemble debt assets. A company has to pay a fixed rate of interest in the form of annual dividends and when it defaults, the preference shares have a right over the arrears too. They are settled before equities and after debts. However, some preference shares can be converted to equity shares. 

Types of preference shares

• Cumulative preference shares
• Non-cumulative preference shares
• Redeemable preference shares
• Non-redeemable preference shares
• Convertible preference shares
• Participating preference shares
• Non-participating shares

What is an equity share?

Equity shares are non-redeemable stakes in a company’s ownership. What this means is that they are the ones that finance a company. Moreover, upon its liquidation, these shareholders are the last ones to get settled. This also means equities are risky assets and the investors bear the entire risk of the business failing.

Then why do people invest in them, you may wonder? 

• They are more flexible than the aforementioned shares and can be transferred and traded openly on the stock market without much delegation or consideration. 
• These investors have a claim on the company’s bonus shares.
• They can also claim a share in the company’s profits and assets. However, dividends aren’t fixed, and how much to disburse is decided by the management.
• These investors get voting rights to directly influence the company’s matters.

While equity shares appear on the liability side of the company and do not have subcategories as such, they can still be classified into the following types for an investor’s understanding:

• Authorised share capital
• Subscribed share capital
• Issued share capital
• Paid-up capital
• Bonus shares
• Right shares
• Sweat equity shares

Difference between equity and preference shares

The parameters in the table below help to distinguish between preference and equity shares.

	Preference Share	Equity Share
Definition	Partial ownership stakes of the company with rights on dividend and capital	Partial ownership of the company can be traded freely
Dividend payout	Preferred over ordinary shareholders	Preference shareholders are paid before equity shareholders, who are paid from the residual.
Rate of dividend	Fixed	Varies
Bonus shares	No	Yes
Capital repayment	Before ordinary equity stocks	Paid last
Voting rights	No	Yes
Role in management	Not allowed	Yes, voting rights on internal matters
Redemption	Can be redeemed	Can’t be redeemed
Convertibility	Some shares can be converted to ordinary equity, convertible preference shares somewhat allowed	Shares cannot be converted
Arrears of dividend	Yes, along with the current year’s pre-fixed rate of dividend	No. Also, the dividends aren’t compulsory to be paid each year. The decision lies with the management
Capitalisation	Lesser chance of over-capitalisation	Higher risk
Types	Various types	No
Financing term	Mid or long-term financing	Long-term financing
Mandate to issue	Not compulsory	Compulsory, if seeking to raise equity capital for the company’s business
Investment denomination	High, going up to a minimum of INR 10,00,000	Low
Type of investors	Investors with more savings and lesser appetite and tolerance for volatility risk, looking for annually paid dividends	Aggressive investors with a risk appetite, who are okay with not being paid a fixed rate of interest but would like to enjoy voting rights
Associated burden	Have to pay dividends that are fixed as part of the contract	Not mandated to pay, can do in case of good performance

So, the question arises: Which share should you pick? 

There is no one-size-fits-all. If you are hoping to make more from the open market, you should invest in ordinary shares that give you the flexibility and opportunity to use the market’s volatility in your favour. However, the risk is higher. 

For a relatively safer investment, you could go for preference shares, though they need heavier investment and come with a fixed rate of dividends. The best way to go about the share market is to diversify, not just when it comes to picking shares, but also while picking the types of shares. Equity shares and preference shares can both give value only if the company you choose is valuable. 

FAQs

• Do I get ownership of the company with preference shares?
  Yes

• Are equity share dividends taxed?
  Yes

• Can preference shares be bought from the open market?
  Yes, if listed.

• How to check if a company’s preference share or equity share is better?
  If you feel that you can earn more from the fixed rate of dividend, choose the preference share.