Equity shares vs Preference shares: Key similarities and differences
A company’s capital is divided into small, equal units of a fixed amount. Each of these units is called a share and confers upon the holder ownership of a percentage of the company. Shares are broadly categorised into two types: equity shares and preference shares.
Before we differentiate between equity shares and preference shares, let’s understand their basics.
What are Equity Shares?
Investors holding units of equity shares get part ownership of the company. Equity shares are also popularly known as common stock or common shares. The monetary benefits of investing in equity shares include capital appreciation and dividends.
A company raises equity share capital through an Initial Public Offer (IPO), a primary market offering. Investors can subscribe to the IPOs or purchase the shares from the secondary market once they are listed on a stock exchange.
What are Preference Shares?
Investing in preference shares gives several preferential rights to the shareholders over equity shares. These shares provide additional benefits over equity shares with respect to dividend sharing. Not only are the preference shareholders entitled to be paid a fixed dividend per share by the company, but they also have the right to get the dividends before the equity shareholders. In case of bankruptcy or liquidation of the company, the preference shareholders receive a share of the liquidation value before the equity shareholders.
However, the preference shareholders do not enjoy any voting rights, unlike equity shareholders. Further, these cannot be traded in a secondary market.
Some types of preference shares are Cumulative Preference Shares, Non-Cumulative Preference Shares, Convertible Preference Shares, Non-Convertible Preference Shares, Participating Preference Shares and Non-Participating Preference Shares.
Features of Equity and Preference Share
The difference between equity shares and preference shares can be understood better if we take a closer look at the main defining features of both share types:
Characteristics of Equity Shares
• The equity shares are permanent and non-redeemable in nature.
• The ownership rights of the equity shares can be conveniently transferred to another investor and easily traded in the secondary market.
• The equity shareholders are also entitled to get dividends on the shares. The company is at the liberty of deciding how much dividend to be paid if any.
• Investing in equity shares can be risky as it is volatile in nature. However, these investments have the potential to generate significant returns in the long term.
Characteristics of Preference Shares
• Preference shareholders get priority over equity investors for dividend payments by the company. Moreover, the former is entitled to higher dividends in comparison to the latter.
• Shareholders are the last to be paid in case of liquidation of the company, but preference shareholders are prioritised over equity shareholders.
• Except for some extraordinary or majorly important situations, preference shareholders do not enjoy any voting rights.
• A company may offer convertible preference shares, which have the feature of being turned into common shares if a shareholder wishes to.
• In India, preference shares must be redeemable within a period of a maximum of 20 years.
• They cannot be traded in the secondary market.
• Preferential shares are generally subject to lower risk compared to equity shares.
Similarities between Equity and Preference Shares
• Both equity and preference shareholders own a company’s capital.
• Public limited companies raise both equity and preferential share capital.
• If the company has issued an irredeemable (convertible) preference share capital, then equity and preference share become permanent. However, all preference shares must be redeemed within 20 years in India.
• Both the share types carry residual claims after employees and creditors.
Investors’ decision on picking equity vs preference shares will depend largely on their risk tolerance and financial objectives. Preference shares could be converted into equity shares but not vice versa. Notably, preference shares are redeemable, whereas equity shares are irredeemable in nature. Only equity shares get voting rights. Except for non-cumulative preference shares, the dividend on the preference shares is cumulative and always consistent.
Q. Which has higher risk: equity or preference share?
Preference shares have comparatively low risk than equity shares.
Q. Who will be entitled to dividends first?
Preference shareholders are entitled to receive dividends first due to their preferential rights over equity shareholders.
Q. What is the role of equity and preference shareholders?
Equity shareholders can take part in voting on important issues in the company as against the preference shareholders.
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