Capital is the lifeblood of any company. Therefore, once the company gets its certificate of commencement of business, it requires money for starting and running the business.
The company can raise money by issuing shares or debentures. When the company arranges funds by issuing shares to the public, it is share capital. In other words, we could say the capital of the company is divided into units of small denomination, which are called shares. Further, there are two kinds of shares, i.e. Equity Shares and Preference Shares.
Content: Equity Shares Vs Preference Shares
- Comparison Chart
- What are Equity Shares?
- What are Preference Shares?
- Key Differences
- Investment Basics
|Basis for Comparison||Equity Shares||Preference Shares|
|Meaning||Equity shares are the ordinary shares of the company representing the part ownership of the shareholder in the company.||Preference shares are those that carry preferential rights on the matters of payment of dividends and repayment of capital.|
|Right to dividend||Paid to preference shareholders first.||Paid to the equity shareholders after the payment of dividends to preference shareholders.|
|Rate of Dividend||Not fixed||Fixed|
|Redemption by the company||Not redeemable during the lifetime of the company.||Redeemable during the lifetime of the company.|
|Accumulation of dividend||Dividend accumulates for the next 3 years, if not paid for the current year.||If a dividend is not paid during the year, it lapses.|
|Voting Rights||They have voting rights||They have voting rights only in special cases.|
|Participation in Management||Yes||No|
|Liquidation||At the time of liquidation, equity shareholders have residual rights over the asset. That means they are paid in the last.||Shareholders have the preferential right over equity shareholders as to repayment. That means preference shares are repaid before equity shares.|
|Convertibility||Equity shares are non-convertible.||Preference shares can be converted into equity shares.|
|Face value||Low||Comparatively high|
|Arrears of Dividend||Equity shareholders have no right to get arrears of the dividend for the previous years.||Preference shareholders generally get the arrears of dividend along with the present year's dividend if not paid in the previous year, except for non-cumulative preference shares.|
What are Equity Shares?
Equity shares are the shares:
- With voting rights
- With differential rights concerning dividends or voting, as per the rules prescribed.
Therefore, equity shareholders are the real owners of the company, as they get voting rights in the general meeting. They get residual profit after paying all expenses and liabilities on the company. They can appoint or remove the directors and auditors of the company. Also, they can participate in the company’s management.
Hence, equity shareholders receive dividends and capital repayment after settling the claim of preference shareholders, debenture holders and creditors. That means the remaining profit after paying dividends to preference shareholders is distributed as dividends among equity shareholders.
Further, the dividend is not paid at a fixed rate to the equity shareholders, so the rate varies yearly. Also, the directors of the company declare the rate of dividend to be paid to equity shareholders.
Moreover, in case of higher profits, the rate of dividend can be more than the rate of dividend paid to preference shareholders. In the opposite case, if there is no profit or the company sustains loss in a financial year, then the shareholders have to go without dividends.
Characteristics of Equity Shares
- They are issued prior to other forms of securities, but they are repaid in the last.
- No fixed rate of dividend on equity shares.
- The dividend is declared on equity shares on the recommendation of the company’s board of directors in the annual general meeting. But it is paid only on the availability of profit. Hence, if no profit is remained after making payment of the dividend to the preference shares, or if the board of directors do not recommend the payment of the dividend, then in such case, no dividend is paid to equity shares.
- The dividend is paid to the equity shareholders after the payment of dividends on preference shares.
- Equity shareholders are the actual owners of the company. Hence, they are entitled to receive notice of meetings, attend meetings, appoint proxy on their behalf and cast votes.
- Equity shares are irredeemable.
- They enjoy voting rights and control over the management of the company.
- They are entitled to all the remaining profit of the enterprise.
What are Preference Shares?
Preference shares are the class of shares that entitle its holder to get priority over the ordinary shares in certain matters. In a nutshell, they are non-equity shares. Preference Share Capital refers to that portion of the issued share capital that have preferential rights concerning:
- Dividend payment at a prescribed rate before the dividend is paid to equity shareholders.
- Dividend during the lifetime of the company.
- In the event of winding up of the company, repayment of capital to the preference shareholders before the repayment of capital to equity shareholders.
Preference Shares are not debt instruments but are similar to one. They give ownership right to the holders but do not grant voting rights. However, if the dividend is not paid to the preference shareholders for 2 years straight (3 years in the case of non-cumulative shares), then voting rights are granted to them.
Characteristics of Preference Shares
- It is a hybrid form of instrument that carries the features of equity shares and debentures.
- They carry preferential rights as to the payment of dividends.
- In the event of winding up of the company, they have the preferential right of repayment of capital over equity shareholders.
- They have a fixed rate of dividend.
- If the articles of association do not specify, then the preference shares are deemed to be cumulative preference shares. In a cumulative preference share, the dividend accumulates if it is not paid in a particular financial year.
- They are redeemed during the lifetime of the company that issues them.
- If the articles of association provide, they can be converted into equity shares.
Types of Preference Shares
- Cumulative Preference Shares
- Non-Cumulative Preference Shares
- Convertible Preference Shares
- Non-Convertible Preference Shares
- Participating Preference Shares
- Non-Participating Preference Shares
- Redeemable Preference Shares
Also Read: Difference Between Shares and Debentures
Key Differences Between Equity Shares and Preference Shares
- Equity Shares are the shares that carry voting rights, and the shareholders are the actual owners of the company. On the other hand, Preference Shares are the shares that carry preferential rights as to payment of dividends and repayment of capital at the time of winding up of the company.
- The rate of dividend is fixed for preference shareholders. As against, the rate of dividend to be paid to the equity shareholders varies from year to year. This means that the rate of dividend depends on the amount of profit earned by the company.
- The company pays dividends to equity shareholders after paying the dividends to the preference shareholders. Hence, preference shareholders are paid dividends before equity shareholders.
- The repayment of capital to equity shareholders is made after the repayment of preference share capital in the event of the winding up of the company. As against, the repayment of capital to preference shareholders is made before the repayment of capital to equity shareholders in the event of winding up of the company.
- The equity shareholders have the right to vote at the AGM. As against preference, shareholders do not have the right to vote. However, they may be provided voting rights in special circumstances.
- Equity shares are irredeemable. However, as per the Companies Act 2013, the redemption of equity shares can be done under a scheme concerning the reduction of capital or buyback of shares. On the other hand, preference shares are redeemable during the lifetime of the company.
- Preference shareholders do not have any right to participate in the company’s management. Conversely, equity shareholders are the real owners of the company, so they have the complete right to participate in the management of the company.
- The face value of equity shares is low, whereas the face value of preference shares is comparatively high.
- Equity shares cannot be converted into preference shares, whereas preference shares can be converted into equity shares.
To invest in these shares, you should know the stock market well. Otherwise, there are a lot of chances that you may suffer loss.
One thing you must remember while making an investment in any of these is to purchase the shares or stock when the market is down because, at that time, the prices are generally low and sell them when the market is up as the prices of shares are relatively higher. Similarly, another point of relevance is you must try to go for a long-term investment; it will give you good returns for longer periods.
The best form of investment is a mutual fund, as the risk is comparatively less than the individual stocks. Do not recklessly believe in any good advice because some investments will give you high returns, but they are the riskiest ones, so think twice before investing anywhere in the stock market.
If you don’t want to invest in mutual funds, then there are still better options for you like; you can directly purchase the stock of any company when they bring a new issue of shares in the form of an Initial Public Offer (IPO) this purchasing is known as buying from the primary market. Before investing money in any company, remember one formula Investigate before you Invest your money in any stocks, as there are chances of money loss.
If you can’t find any such direct purchasing, then you can register with a broker and create a Demat account. It will facilitate purchasing the securities of companies already listed on the Stock Exchanges like National Stock Exchange or Bombay Stock Exchange. This type of purchasing is buying from the Secondary Market.
Also Read: Difference Between Share and Stock
Above all, while bold and adventurous investors prefer equity shares, cautious and conservative investors prefer preference shares. When a firm has to decide the capital structure, it must choose a mix of the two types of shares in the company’s share capital.