If you are interested in investing in shares, it is a wise decision to fully understand the different types of shares first. There are many shares available in the market, so make an informed decision to opt for the right choice.
There are broadly 2 types of shares by which a company can raise its share capital – equity shares and preference shares.
This article will cover the meaning of these 2 types of shares, their types, and the major differences between equity shares and preference shares.
What Are Preference Shares?
As the name suggests, preference shares provide a slight advantage over common shares. Preferred shareholders receive a fixed rate of dividend, priority over other shareholders in the settlement of the company’s assets, and a share of the profits and revenue limited to the dividend. If preference shares are listed on the stock exchange, they can be bought through the primary market or through private transactions which typically require a minimum costing size of INR 10,00,000.
What are the limitations of Preference Shares?
Even though they get priority over regular equities, preference shares have some drawbacks:
- Preference shareholders typically do not have voting rights, which means they are unable to determine the company’s future course of action.
- Preference shareholders do not get any claim or entitlement to 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. 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
Cumulative preference shares are those in which unpaid dividends build up until they are paid. Dividend arrears are entitled to these shares’ holders prior to any dividend being distributed to common shareholders.
Non-Cumulative Preference Shares
Preferred stock that does not grant investors the right to receive any missed dividends is referred to as noncumulative.
Redeemable Preference Shares
Preference shares that have a set rate and redemption date and can be bought back or redeemed by the issuing company are known as redeemable shares. These shares offer a buffer against inflation, which benefits the company.
Non-Redeemable Preference Shares
Non-redeemable preference shares are those that are only redeemable during the company’s liquidation.
Convertible Preference Shares
Dividend-paying preferred stock that can be converted, at a fixed conversion ratio, into normal stock after a predetermined date is known as convertible preferred stock. One sort of hybrid security combining elements of debt and equity is convertible preferred stock.
Participating Preference Shares
The term “preferred stock” is frequently used to describe participating preference shares. These investments are a special kind of equity that provides both the chance for extra profits and the security of fixed dividends. They draw in investors who want to be part of the company’s growth but also want a certain level of security.
Non-Participating Shares
Equity in a business that pays a set interest rate as opposed to a portion of the profits. You are not entitled to a portion of the excess profits if you own non-participating shares.
What Are Equity Shares?
Equity shares are ownership interests in a company that are not redeemable. This implies that they provide the funding for a business. Furthermore, these shareholders are the last to receive settlements following its liquidation. This also implies that stocks are risky investments since investors can bear the risk of losses if the company does poorly.
One may wonder then, why do people invest in them? Trading equity shares can be simpler than other investments, though research and understanding of market dynamics is necessary. These investors are entitled to bonus shares of the business. They can also claim a portion of the business’s assets and earnings and vote on issues that directly affect the company.
What Are the Limitations of Equity Shares?
The following are the drawbacks of equity shares:
- While the investors can claim a share in a company’s profits and assets, the dividends are not fixed. How much to disburse is decided by the management.
- Equity shares carry a higher level of risk as their value is significantly subject to factors such as the company’s financial performance and market conditions.
- In the event of a company getting bankrupt or facing similar financial distress, equity shareholders are the last in line to receive the payout.
Types of Equity Shares
Authorised Share Capital
It pertains to the highest quantity of shares that a business may lawfully issue or sell in accordance with its corporate charter.
Subscribed Share Capital
Any capital raised through subscribed shares is referred to as subscribed share capital. It’s the total value of the shares that buyers consent to buy in a fresh issuance.
Issued Share Capital
The total amount of shares that a business has distributed to its investors is known as Issued Share Capital. The total amount of shares that a business has distributed to its investors is known as Issued Share Capital.
Paid Up Capital
The sum of money that a business has obtained from investors in return for stock shares is known as paid-up capital.
Bonus Shares
Bonus shares are extra shares that a business issues to its existing shareholders at no additional expense. Depending on how many shares a shareholder currently owns, they will receive these bonus shares.
Right Shares
The shares that a company offers to its current shareholders at a reduced price are referred to as the right shares. A company offers shares to its shareholders. The freedom to trade with other market participants is enjoyed by each and every current shareholder. The right issue’s offer may also be rejected by the current shareholders.
Sweat Equity Shares
A company may issue its directors, employees, or other service providers with sweat equity shares in return for their non-monetary contributions to the business, such as their time, labour, or intellectual property.
Difference Between Equity Shares and Preference Shares
|
Feature |
Equity Shares |
Preference Shares |
| Definition | Partial ownership of the company can be traded freely | Partial ownership stakes of the company with rights on dividend and capital |
| Dividend Payout | Preference shareholders are paid before equity shareholders, who are paid from the residual | Preferred over ordinary shareholders |
| Rate of Dividend | Variable | Fixed |
| Bonus Shares | Yes | No |
| Capital Repayment | Paid last | Before ordinary equity stocks |
| Voting Rights | Yes | No |
| Role in Management | Yes, voting rights on internal matters | Not allowed |
| Redemption | Non-redeemable | Redeemable |
| Convertibility | Shares cannot be converted | Some shares can be converted to ordinary equity, convertible preference shares somewhat allowed |
| Arrears of Dividend | No. Also, the dividends aren’t compulsory to be paid each year. The decision lies with the management | Yes, along with the current year’s pre-fixed rate of dividend |
| Capitalisation | Higher risk | Lesser chance of over-capitalisation |
| Financing Term | Long-term financing | Mid or long-term financing |
| Mandate to Issue | Compulsory, if seeking to raise equity capital for the company’s business | Not compulsory |
| Investment denomination | Low | High, going up to a minimum of INR 10,00,000 |
| Type of Investors | 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 | Investors with more savings and lesser appetite and tolerance for volatility risk, looking for annually paid dividends |
| Associated Burden | Not mandated to pay, can do in case of good performance | Have to pay dividends that are fixed as part of the contract |
Conclusion
Equity shares have higher risk and volatility, but they provide voting rights and the possibility of large returns. In contrast, preference shares have a lower potential for return and rarely grant voting rights, but they do offer fixed dividend payments and increased stability. There is no one-size-fits-all approach; the right choice for you depends on your investment goals and risk appetite.
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Disclaimer: This article is for information purposes only and should not be considered as stock recommendation or advice to buy or sell shares of any company. Investing in the stock market can be risky. It is therefore advisable to research well or consult an investment advisor before investing in shares, derivatives or any other such financial instruments traded on the exchanges.
FAQs
What is the difference between preference shares and equity shares? Which one is better?
Shares of equity have higher risk and volatility but also provide voting rights and the possibility of large returns. In contrast, preference shares have a lower potential for return and typically do not grant voting rights, but they do offer fixed dividend payments and increased stability. The right choice depends on your investment goals and risk tolerance, as well as the value of the company.
Do I get ownership of the company with preference shares?
Yes. It must be noted that preferred stockholders are partial owners of a company, but unlike common shareholders, preferred shares do not come with any voting rights.
Are equity share dividends taxed in India?
Yes, In India, dividend income is subject to taxation. A TDS of 10% is applied to dividend payouts exceeding INR 5,000 in a financial year. However, you can avoid TDS by submitting forms 15G/15H if your total income falls below the tax exemption limit.
Can preference shares be bought from the open market?
Yes, if listed. Investors can purchase and sell these shares based on their current price once they are listed on the stock exchanges, following an IPO.
Is it possible to trade preference shares in India?
Yes, it is possible to trade preference shares in India as they are listed in the same way as regular stocks. Preference share liquidity, however, can change based on the particular conditions of each share.
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