Difference Between Equity Share and Preference Share: Factors to Keep in Mind While Choosing
Distinguish Between Equity Shares and Preference Shares: Introduction
Everyone wants to have a different source of income in their life. And for that, some will start investing their actively earned income to make a good amount of passive income. We as an investor, invest our money to maximise the return and grow the wealth. But there is not only one way to achieve it. There are different instruments available in the market through which you can grow your money. Each instrument has its own speciality, some of them will help you grow your money in a very short period while some will take time to grow. In this article, we will learn about two such market instruments in which investors put their money in - equity shares and preference shares
What will we learn?
- Meaning of equity and preference shares
- Types of equity and preference share
- Difference between equity and preference share
- Factors to keep in mind while choosing equity and preferences shares
What are Equity Shares and Preference Shares?
Equity Shares are non-redeemable shares that are issued to the public at large. Investors can redeem the share only when the company is closed. It is the source of long-term financing for any company. Here each member is part owner and holds fractional ownership in the company. Holders of equity shares have voting right in business proceedings.
Preference Shares are commonly known as preferred stock. Investors can redeem their invested amount after a fixed period. When it comes to payment of capital, dividend and profit, preference shareholders hold preferential rights over equity shareholders.
Major Differences Between Equity and Preference Shares
- Equity shares cannot be redeemed while preference shares can be redeemed after a fixed period
- Equity shares hold voting right in the company whereas preference shareholders hold the preferential right
- If a company is closed then preference shareholders get preference over equity shareholders in terms of payment of capital and profit
- The annual dividend is firstly paid to preference shareholders and then to equity shareholders
Types of equity and preference shares
Following are the types of Equity Shares:
- Authorized share capital - It is the maximum limit of share capital that can be used by the company
- Issued share capital - This is the amount of share capital issued to shareholders of the company
- Subscribed share capital - Amount of shares that are subscribed by the shareholders
- Paid-up capital - It is part of subscribed capital including the actual paid-up amount by shareholders
- Right shares - This is a share containing certain rights attached to shares of the company. These shares are issued to safeguard the interest of existing shareholders
- Bonus shares - Shares that are issued to shareholders in form of dividends are bonus shares
- Sweat equity shares - Shares that are issued to appreciate the employees or directors for their work are sweat equity shares
Following are the types of preference share:
- Cumulative preference shares - let's take an example to understand this: If any company paid Rs 80 instead of Rs 100 in the current year. Then next year they have to pay Rs 120 in case of cumulative preference shares
- Non-cumulative preference share - In this case, there is no accumulated dividend. If any shareholders got Rs 80 instead of Rs 100 in the previous year then he is not entitled to Rs 120 in the current year he will only be entitled to Rs 100
- Redeemable preference share - Shares that can be redeemable after a fixed period are known as redeemable preference shares
- Irredeemable preference share - When shares are not redeemed during the active period then those shares fall under irredeemable preference share
- Convertible preference share - When preference shares can be converted into equity shares at a fixed rate then it is known as a Convertible preference share
- Non-Convertible share - Shares that cannot be converted into equity shares are known as Non-Convertible shares
- Participating preference shares - Shares that,rights contain the right of participation in the extra surplus or earning during liquidation are participating preference shares
- Non-participating preference share- Share which has a right of participation in the extra surplus or earning during liquidation are non-participating preference shares
Differences between equity and preference shares
|Basis||Equity shares||Preference shares|
|Definition||Equity shares represent ownership of the shareholders, and one can redeem the invested amount only at the time of winding up||Preference shareholders are carrying preferential rights in terms of receiving dividends, profits etc|
|Dividend rate||Dividend rate fluctuates as per the earnings of the company||Dividend rate is fixed in case of preference share|
|Bonus shares||Equity shareholders are entitled to bonus shares||Preference shareholders are not entitled to bonus shares|
|Convertibility||Equity shares cannot be converted into preference shares||Preference shares can be converted into equity shares|
|Redemption||Equity shares cannot be redeemed||Preference shares can be redeemed after the fixed period|
|Rights||Equity shareholders are carrying voting right and can take participation in the company's decision||Preference shareholders are carrying preferential right|
|Types||Equity shares are considered as an ordinary stock||It can be convertible, non-convertible, participating, non-participating, cumulative and non-cumulative.|
|Claim for assets||Do not have any right to claim for the asset at the time of winding up||Have a right to claim for the asset at the time of winding up|
|Payment of dividend||Equity shareholders will get dividend after preference shareholders||Preference shareholders have a preference over equity shareholders in terms of dividend|
|Risk||Risk is high in the case of equity shares when compared to preference shares||Risk is low in the case of preference shares|
Factors to keep in mind while choosing equity and preference shares:
- If you are among those investors who want a fixed amount of money as your dividend income then you should go for a preference share because preference shareholders get preferential rights. In equity shares, you may or may not get a dividend but in the case of preference shares you get your dividend before equity shareholders
- If you consider ownership then you should be equity shareholders. Here you can get voting right in the critical decision of the company whereas preference shareholders are not carrying any voting right
- If you are someone who has a low-risk appetite then I would suggest you go for preference shares in a company because preference shares have the preferential right over profit and dividend compared to equity shares
- If you want to take part as an owner in the management of the company then you should go for equity shares as they are the part owners holding ownership and voting rights in the decision made by the management of the company
Both equity and preference shares are two common investment instruments in the market. However, the differences between the two make them preferred by a different group of investors having unique financial goals.
Which contains more risk equity or preference share?
Preference shares have low risk in comparison to equity shares because they are safer than equity shares as they pose any threat
Who will be entitled to dividends first?
Preference Shareholders as they carry preferential rights over equity shareholders
What is the role of equity and preference shareholders?
Equity shareholders can take part in the management of the company as they are the part-owners of the company whereas preference shareholders do not take part in management.
Which shareholders are entitled to bonus shares?
Equity shareholders. Preference shareholders are not entitled to bonus shares
How to buy preference shares?
You can buy preference shares through the primary market (IPO or FPO) or from the secondary market which is on the exchange or over the counter.