A share is a unit of ownership in a company and has an exchangeable value that is influenced by market forces. As per Section 43 of the Companies Act, 2013, a company’s share capital is of two types of shares, namely – equity shares and preferential shares.
The major point of difference between equity share and preference share pertains to voting rights and distribution of dividends.
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Companies issue these shares to the public to raise capital. The funds thus raised are used for the expansion of a start-up.
Since equity shares are non-redeemable, they serve as a long-term source of finance for companies.
The share capital is held by the company throughout and is distributed at the event of winding up.
The fact equity shareholders avail the residual share during liquidation makes them the actual risk bearers of a company. In fact, it is also a point of origin of the difference between equity share and preference share.
Equity shares come with voting rights, and its holders are also entitled to receive surplus and claim company assets.
The company’s management determines the rate of dividend be distributed among such shareholders. Moreover, these shares are transferable and can be transferred without consideration.
Notably, the unit of shares held by investors signifies the proportion of ownership they have in a said company.
Generally, they are traded in the market through a stock exchange. The value of these shares is expressed in issue price, face value, market price, book value, intrinsic value, etc.
Equity shares appear on the liability side of a company’s balance sheet. They do not have any types as such and are hence considered as ordinary stocks. Nonetheless, they are usually categorised as –
- Authorised share capital
- Subscribed share capital
- Issued share capital
- Paid-up capital
- Bonus shares
- Right shares
- Sweat equity shares
Equity shares offer substantial dividends to shareholders and also entitle them to benefit from price appreciation in investment value.
Also, their liquidity enables shareholders to sell them off effortlessly and gives rise to another point of difference between equity share and preference share.
On the other hand, besides being a permanent source of capital, equity shares also help companies to secure credit easily.
Both investors and creditors consider companies with large equity capital as creditworthy. Furthermore, the liability arising out of equity shares are required to be paid, and companies are also not obligated to pay a dividend to shareholders.
Let’s proceed to the fundamentals of preference shares to understand the origin difference between equity share and preference share.
The capital that a company raises through the issuance of preference shares is termed as preference share capital.
These shares come with a fixed rate of dividend and a preferential right to avail profits and claim assets during liquidation.
In fact, these shares are ranked between debt and equity in terms of priority and repayment of capital.
Like equity shares, preference shareholders are also partial owners of a company. However, they are not entitled to voting rights and hence do not really possess the power to control or influence company-oriented decisions.
Also, shareholders do not have a claim over the bonus shares and are a prominent preference shares and equity shares difference.
What is most noteworthy is that preference shares are similar to debentures, and they could be converted to preferred stock.
Furthermore, preference share issuers can repurchase the shares at a given date. These shares extend substantial dividends to their holders but do not come with a closing date.
The decision to declare dividend on preference shares lies with the management, and it is not mandatory in case of loss. This is the most crucial difference between equity share and preference share.
Also, if a company decides not to offer a dividend in a particular year, they must pay it to the shareholders later. Notably, shareholders can convert their preference shares into equity shares and cannot be traded in the market.
These shares are reported in the section of stockholders’ equity on the balance sheet and are placed before all other stocks.
The following are the major types of preference share –
- Cumulative preference shares
- Non-cumulative preference shares
- Redeemable preference shares
- Non-redeemable preference shares
- Convertible preference shares
- Participating preference shares
- Non-participating shares
It must be noted that dividends paid on preference shares are not deducted from taxes. Also, redeeming such shares creates a financial burden on the company and erodes its capital. Similarly, when profits are earned companies must pay off the arrears dividends, especially in case of cumulative preference shares.
With that being discussed, let’s find out the fundamental difference between equity and preference shares.
These parameters highlighted in the table below help to distinguish between preference and equity shares effectively.
|S.N.||Parameter||Equity Share||Preference Share|
|Definition||Equity shares represent the extent of ownership in a company.||Preference shares come with preferential rights when it comes to receiving dividend or repaying capital.|
|Dividend payout||Shareholders receive dividends after all liabilities have been paid off.||Preference shareholders are given more priority over equity shareholders when it comes to the dividend payment.|
|Rate of dividend||The rate fluctuates as per earnings.||Rate of dividend remains fixed.|
|Bonus shares||These shares are entitled to receive bonus against existing shareholdings.||These shares do not offer bonus against existing shareholdings.|
|Capital repayment||It is repaid at the end.||It is repaid before equity shares.|
|Voting rights||The shares come with voting rights.||Preferential shares do not have voting rights.|
|Role in management||Equity share comes with the power to participate in the company’s management.||Preference share does not extend management rights.|
|Redemption||It cannot be redeemed.||It can be redeemed.|
|Convertibility||Shares cannot be converted.||Shares cannot be converted.|
|Arrears of dividend||Shareholders are not entitled to avail arrears of dividends.||Shareholders are likely to avail arrears of dividend along with current year’s dividend.|
|Capitalisation||There is a high chance of over-capitalisation.||There is a relatively less chance of over-capitalisation.|
|Types||They are categorised as an ordinary stock of a company.||There are several types. E.g. participatory, non-participatory, convertible, non-convertible, cumulative, non-cumulative, etc.|
|Financing term||It serves as a means of long-term financing.||It serves as a means of midterm and long-term financing.|
|Mandate to issue||Companies must issue equity share capital.||All companies do not need to issue preference share capital.|
|Investment denomination||Equity shares have a lower denomination.||Most preference shares come with a high denomination.|
|Type of investors||It is suitable for risk-taking investors.||It is suitable for risk-averse investors.|
|Associated burden||Paying off equity dividend is not mandatory and depends entirely on the company’s profit.||Companies are obligated to pay dividends to its preference shareholders.|
Based on the difference between equity share and preference share, it can be said that both shareholders benefit in different ways. While equity shareholders enjoy voting right and can partake in company-oriented decisions, preference shareholders have an upper-hand at the distribution of dividends.
Similarly, risk-averse individuals would find preference shares to be a more convenient investment option than equity shares which have a higher risk factor. On the other hand, from the perspective of a company owner, equity shares serve as a long-term financing tool. Also, it has a lower financial obligation to shareholders when compared to preference shares.
Hence, depending on one’s risk-taking capacity and financial goals, investors can select the most suitable investment option from equity vs preference shares. Regardless, market knowledge should be given more priority when it comes to investment.