Are you looking to build your wealth through stock market investments?
But, the lack of knowledge has left you feeling stuck?
…and the complex terminologies on the internet provide no hunky-dory either?
Well!
Do not worry. We have got you covered.
Let us take you through the difference between equity shares and preference shares while covering the basics of the matter entirely.
A share is a part of ownership in a company acquired through an exchange of capital. The market value of shares fluctuates depending on market forces or external influences on the market.
As per section 43 of the companies act 2013, the share capital of a company can have two types of shares – equity shares and preference shares.
The primary difference between the shares is dividend payouts and voting rights.
However, to fully understand the difference between equity shares and preference shares, we need to understand both of these shares in more detail.
Equity shares are the shares issued by the company to the public for fund generation. This raised fund is typically used for the expansion of the business. The Equity shares serve as a source of finance for the long term, and they are also non-redeemable.
The main difference between equity shares and preference shares is that the equity shareholders are the real risk bearers of the company. Equity shareholders also possess voting rights and can claim company assets and dividends.
The company’s management determines the dividend rate they want to provide to such shareholders. One can quickly transfer Equity shares and the associated rights and duties to another person without consideration.
The number of shares a person has of a particular company directly signifies a shareholder’s ownership of the company. The trading of Equity shares in the stock market happens through a stock exchange.
There are various types of equity shares depending on ownership, dividend payments, preference, employment in the company, etc.
So, we have listed below all the types of equity shares, and they are as follows:
Ordinary shares are the shares that a company issues to raise funds for meeting its long-term expenses. An investor gets ownership of the firm in exchange for these shares. The portion of ownership received by an investor is equivalent to the number of shares they hold. The ownership allows shareholders to have a say in the company’s decision-making, thereby providing them with voting rights.
Preference equity shareholders lack voting rights or membership rights that ordinary shareholders possess. But, these shareholders are prioritised during dividend payments above ordinary shareholders, and they also receive the assurance of cumulative dividend payments.
Preference equity shares are further classified into two types:
Participating preference equity shareholders receive a specific amount of profits and bonus returns in a specific financial year. However, these benefits largely depend on the company’s success.
Non-participating preference equity shareholders do not receive any such benefits.
If the company goes insolvent, preference equity shareholders will receive the repayment of capital before the ordinary shareholders during the winding-up phase.
When a company has access to retained earnings, it decides to distribute its profit in the form of a bonus issue. Hence, Bonus shares are the type of equity shares that the company issues to its existing shareholders from its earnings.
Since the issue is made to the existing shareholders, there is no increase in the company’s market capitalisation. However, market capitalisation does increase when other types of equity shares are issued.
Right shares are exclusive shares reserved for only specific or premium investors, and these shares facilitate an increase in the equity stake of a particular shareholder.
The main objective behind issuing right shares is to raise money from premium investors for a specific financial requirement. Hence, the issue of such shares happens at a discounted price.
Sweat equity shares are those shares that are received only by the directors and employees of a company.
The shares are issued to the employees or directors as a token of appreciation for their excellent work.
It is issued to applaud the contribution of such employees and directors to the intellectual property rights, know-how, or value addition to the company; sweat equity shares are issued at a discount to such directors and employees.
Employee stock options (ESOPs) are a grant provided by the company to its employees and directors for retention and incentive purposes.
This grant states that an employee can purchase certain shares at a predetermined price on a future date under the terms specified in the Employee stock option plan (ESOP).
After this grant is offered, it is exercised only for those employees or directors who have accepted it.
When a company decides to conduct a buyback of its shares, the shares repurchased are called Treasury Stock.
Hence, treasury stocks are those equity shares repurchased from the stock market by the company.
Equity shares offer capital appreciation to the shareholders based on their investment value. These shares also provide the benefit of substantial dividends.
Many equity shares, especially with a high trade volume, are highly liquid, enabling the shareholder to sell them quickly. They are also permanent sources of capital and help secure company credit for the long-term, thereby allowing the shareholders to receive long-term benefits.
Many investors give high credits to companies with substantial equity capital because mainly they are large-cap stocks of established companies with a long-term past record. This makes it safer for investors to invest in such companies. Further, the payment for any liability arising out of equity shares is mandatory.
However, a red flag could be that the companies are not liable to pay dividends to the shareholder, and they can use the retained earnings for the expansion and growth of the business.Hence, equity shares might not be your go-to choice if you are looking for steady dividend payouts.
Preference Shares are those shares given to the public at a fixed dividend rate. These shareholders are prioritised over the ordinary shareholders in terms of paying dividends, thus providing fixed-income security. These shareholders have preferential rights over the profits and claims over company assets in the event of liquidation.
Preference shareholders, however, do not have voting rights in the company as compared to equity shareholders. Preference shareholders do not have any right to influence company decisions, and they also do not have the right to claim bonus shares.
One can convert preference shares into preferred stock. However, they cannot be converted into equity shares and traded in the market except in some cases.
The issuers can repurchase preference shares on a given date. These shares provide substantial dividends.
The company may not pay dividends to preference shareholders in case of loss. However, the company must pay this dividend to its shareholders later.
Preference shares have been categorised into multiple types depending on various factors. The categorisation factors are dividend payout, convertibility, redeemability, participation and dividend rates.
There are two classifications of preference shares, depending on the payment of dividends of the shares, and they are as follows:
A cumulative preference share is preferred stock with leverage. This agreement for this stock states that if any dividend payments are missed in the past, the company must pay the missing dividends to owners of cumulative preference shares first.
Hence, cumulative preference shares include a clause that allows stockholders to receive payments in arrears. When a company’s profits are insufficient to pay dividends in a given year, cumulative dividends are paid the following year.
Non-cumulative preference shares are the shares that do not receive a dividend if the company has missed them in a particular year.
Because non-cumulative preference shareholders are paid from the current year’s net income, this is why such shareholders do not enjoy cumulative dividends.
As a result, if a corporation makes a loss in a given year, shareholders cannot collect outstanding dividends from future revenues.
There are two classifications of preference shares based on convertibility of shares, and they are as follows:
Convertible preference shares are essentially those shares that allow holders to convert them into equity shares at a predetermined rate.
In particular, as indicated in the memorandum, these shares can only be converted after a set period has passed.
Convertible preference shares are appropriate for investors who want to obtain preferred share dividends. It also benefits people who want to profit from changes in the price of stock shares.
As a result, such shares assist investors in generating consistent earnings while also providing the possibility to earn more significant returns regularly.
Non- convertible preference shares are those shares that carry preferential rights and cannot be exchanged for an issuer’s equity share.
Instead, they are redeemed at the expiry of their tenure.
Holders of Non-convertible preference shares have no right to receive equity shares when they reach maturity.
After compensating the equity shareholders, such shares have the right to partake in any further profits.
There is one category of preference shares based on the rate adjustment of shares, and that is as follows:
An Adjustable Rate preference share is a stock whose dividends are linked to a benchmark, most commonly a T-bill rate.
The adjustable-rate preference share’s dividend value is defined by a predetermined formula to change with rates. These values of frequently changing rates are more stable than fixed-rate preferred stocks, given the impact of inflation.
The rate of dividend paid on the adjustable-rate preference share is a variable rate significantly influenced by current market rates. It directly impacts the number of dividends paid to shareholders during the investment.
There are two classifications of preference shares based on the redeemability of shares, and they are as follows:
Redeemable preference shares are also known as callable preferred stock. These shares are one of the most efficient ways to fund large corporations.
Redeemable preference shares are easily traded on stock markets and have a mix of equity and loan funding. A firm usually has the authority to repurchase shares that have served its purpose.
As a result, redeemable preference shares are repurchased at a fixed rate on a specified date or by making an advance announcement.
These shares help reduce the impact of inflation and monetary rate declines.
The irredeemable preference shares cannot be reimbursed or redeemed throughout the company’s active life.
Shareholders will have to wait until the company decides to wind down or liquidate its current activities before taking action.
The irredeemability factor turns the company’s shares into an everlasting obligation. Because these shares lack an integrated redemption clause, they cannot be purchased back at the issuing company’s discretion.
In India, a company cannot issue irredeemable preference shares.
There are two classifications of preference shares based on the participation of shares, and they are as follows:
Participating preference share is a preferred type that allows shareholders to participate in the company’s additional earnings. The participation feature boosts the stock’s value, allowing the issuer to sell it for more money.
The participation comes on top of the fixed dividend, similar to most varieties of preferred stock.
During liquidation, these shareholders receive additional consideration and the right to receive the repurchasing price of the stock and a pro-rata portion of any remaining proceeds distributed to common shareholders.
Non-participating preference shares are not entitled to any surplus earnings or assets during a company’s liquidation. This sort of stock allows its owners only to receive pre-determined dividends.
Regardless, these shares are entitled to a fixed rate of return in the form of a dividend. They enjoy preference rights that enable them to be paid before common stockholders. This right extends to even the previous unpaid dividends, which the company should clear before paying off dividends to holders of common stocks.
Preference shares are a particular type of shares as they get the first claim on company profits before any other shareholder.
Preference shareholders are entitled to fixed dividends delivered at predetermined rates by the company. This policy is why preference shares are considered less risky than equity shares because there is more security in receiving dividends than in equity shares.
During the company’s liquidation process, preference shares are preferred for capital repayment over equity shares.
According to the Income tax act 1961, the dividends earned from preference shares will be exempted from tax up to INR 10 lakh.
However, the preference shareholders do not enjoy any voting rights and they might not receive dividends when the company has incurred a loss except in the case of cumulative preference shares.
The ultimate criteria in which equity shares and preference shares differ are none other than the methodology of dividend payouts and voting rights.
In this article, we have read, time and again, that preference shares receive preference in terms of dividend payment and capital repayment.
The preference share also receives dividends at a company’s predetermined fixed rate. However, equity shares might or might not receive dividends depending on the company’s profits.
In many cases, the company is obliged to pay preference dividends year after year, but the company is in no manner obliged to pay dividends to the equity shareholders.
Hence, some investors believe that preference shares are safer than equity shares because of their steady dividend payout policy.
But, the downside happens to be a lack of say in the critical matters of the company.
Preference shares do not enjoy voting rights. Hence, they cannot interfere in the critical matters of the company, but equity shares do have exclusive voting rights to do so.
But, these differences are not enough for an investor to decide their investment choices.
So, to help the investors make a well-informed and thoughtful decision, we have provided an all-encompassing comparison chart stating the difference between equity and preference share.
The ensemble comparison chart is as follows:
Serial No. | Basis | Equity Shares | Preference Shares |
1. | Definition | Equity shares represent certificates of ownership held by a company’s investors in exchange for the capital provided. | Preference shares are shares that enjoy preference over other ordinary shareholders for claims over the company’s profits and assets. |
2. | Types of Return | Equity shareholders enjoy substantial returns in the form of capital appreciation. | Preference shareholders enjoy steady dividend payouts. |
3. | Dividend payout | Equity shareholders receive dividends after dividend payments of preference shareholders. | Preference shareholders receive dividends before any other shareholders. |
4. | Rate of Dividend | An equity share’s dividend rate is determined by the company’s profits. | Preference shareholders receive dividends at a fixed rate. |
5. | Eligibility for Bonus Shares | Equity Shareholders are eligible to receive bonus shares against their existing shares holdings. | Preference shareholders are not eligible to receive bonus shares. |
6. | Repayment of capital | Equity shareholders are paid at the end of the company’s liquidation process. | During the company’s winding up or liquidation process, preference shareholders are paid before the other existing shareholders. |
7. | Voting rights | Equity shareholders enjoy a say and exclusive voting rights in the company. | Preference shareholders do not have any say and voting rights in the company. |
8. | Say in management decisions | Equity shareholders have a say in the critical matters of the company and can participate in management decisions because of their exclusive voting rights. These shareholders are allowed to interfere in the company’s managerial decisions to the extent of their ownership. | Preference shareholders do not have any right to interfere in the company’s managerial decisions. They do not get any say in the critical matters of the company due to a lack of voting rights. |
9. | Redemption | The Equity Shares cannot be redeemed, and they are the long term financial resources of the company. | Preference shares are redeemable depending on the type of their redemption. |
10. | Convertibility | Equity shares are not allowed to be converted into any other type of shares. | One can convert preference shareholders into equity shares if they are convertible preference shares. |
11. | Outstanding Dividends | If the company has not paid a dividend in the previous years, they are not obliged to pay outstanding compensation to the equity shareholders. | If the company has not paid a dividend in the previous years, they are obliged to pay outstanding dividends to the preference shareholders who hold cumulative preference shares. |
12. | Capitalisation | There are high chances of capitalisation in terms of equity shares. | There are low chances of capitalisation in terms of preference shares. |
13. | Types of shares | The various types of Equity shares are as follows:
|
The various types of Preference Shares are as follows:
|
14. | Term of financing | Equity shares are a source of long-term financing. | Preference shares are a source of medium to long-term financing. |
15. | Mandate | Companies must issue equity share capital to get listed on the Stock exchange. | All companies do not need to issue preference share capital. |
16. | Investment | The investment cost for equity shares is low. | The investment cost for preference shares is comparatively higher than for equity shares. |
17. | Investor suitability. | Equity shares are suitable for investors with a high-risk appetite. | Preference shares are suitable for investors with a low-risk appetite. |
18. | Obligation for dividend payment | A company is not obliged to pay dividends to its equity shareholders. | A company is obligated to pay dividends to its preferred shareholders. |
19. | Liquidity | Equity shares are highly liquid, and experience quick trading on the stock market. | Preference shares are not liquid, but the company can buy back these shares. |
20. | Insolvency | During the insolvency of a firm, equity shareholders are paid after full repayment of preferred shareholders. | During insolvency of a firm, preference shareholders are paid before equity shareholders, and they also have a preferential claim over the company’s assets. |
21. | Liquidation | Equity shareholders are paid after payment to creditors and preference shareholders during liquidation. | Preferred shareholders are paid after payment to creditors but before equity shareholders during liquidation. |
The one similarity between equity shares and preference shares is that they both are the owned capital of the company.
In a nutshell, an active investor can invest in equity shares as they are traded highly in the stock market. But, an investor with a less risk appetite looking for steady returns should opt for preference shares.
If allowed by the company's articles of association, an Indian Private Limited Company or Limited Company can issue preference shares under the Companies Act, 2013.
All preference shares issued by an Indian firm must be redeemable and redeemed within 20 years from the date of its issue. The stock exchanges do not trade preference shares, and as a result, they are not accessible to retail investors.
Preference shares are usually issued through a private placement. Financial institutions, Hindu Undivided Family (HUF), and other lending firms receive this. Preference shares are rarely offered to retail investors.
A company's ownership is represented through equity shares.
Preference shares have priority access to the company's profits and assets.
The voting rights and claim to the company's dividends and assets are significant differences between equity and preference shares.
Equity owners enjoy voting rights, whereas preference shareholders enjoy preferential rights.
At the bankruptcy and liquidation of the company, only after preference shareholders have been paid in full are equity stockholders paid. Preference shareholders have the first right after creditors on the assets.
As a result, they receive payment before equity shareholders.
Equity stockholders are paid only after creditors, and preference shareholders have been paid.
Preference shareholders are compensated after making payments to the creditors and before an equity stock combination.
The classification of preference shares can be perceived as either equity or liability or a mix of both. Preferred shares are an equity instrument that gives owners preference rights in the event of a dividend payment or the underlying company's liquidation.
Also, the firm has a contractual commitment to pay a stream of set dividend payments in the future, and preference shares will be classified as financial liabilities. This information means that the 'dividends' will be recognised as interest payments and included in the Statement of Comprehensive Income as an expense.
All preference shares can be equity shares, but all equity shares cannot be preference shares.
A person who owns an Equity share cannot convert it into a preference share, whereas a person who owns a preference share can change it into an Equity share.
The voting power of equity owners is unlimited, whereas the voting power of preference shareholders is limited.
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.
Open Demat Account &
Trade @ Rs15 per order.
“Filing of complaints on SCORES – Easy & quick”
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.