Difference Between Equity Shares and Preference Shares

Understanding the distinction between equity and preference shares is fundamental for anyone participating in the stock market. Both these financial instruments represent ownership in a company, but they come with different rights, privileges, and risks. This guide provides an in-depth analysis of these two types of shares, helping investors make informed decisions.

Equity shares or ordinary shares, represent ownership in a company. Shareholders who hold equity shares are considered the real owners of a company and enjoy voting rights, the right to receive dividends, and the right to share in the residual profits.

Key Features of Equity Shares

Equity shares represent a form of ownership in a company and come with distinct rights and responsibilities. Understanding their core features can help you make informed investment decisions. Here are the key highlights:

• Ownership Rights: Equity shareholders are part-owners of the company.
  

• Voting Rights: They can vote on important corporate matters, such as electing the board of directors.
  

• Dividends: Dividends are not fixed and depend on the profitability of the company.
  

• Residual Claim: In case of liquidation, equity shareholders receive their share only after all liabilities and preference shareholders are paid.
  

• Market Liquidity: Equity shares are generally traded on stock exchanges and offer liquidity.

Types of Equity Shares

Equity shares can be classified based on their purpose and the stage at which they are issued. Each type serves a specific role in a company’s capital structure. Here's a quick overview of the main categories:

• Authorised Share Capital: Maximum capital a company is authorised to issue.
  

• Issued Share Capital: Part of authorised capital offered to investors.
  

• Subscribed Share Capital: Portion of issued capital subscribed by investors.
  

• Paid-up Capital: Part of subscribed capital paid by investors.
  

• Bonus Shares: Free shares issued to existing shareholders from retained earnings.
  

• Rights Shares: Shares offered to existing shareholders at a discounted price.
  

• Sweat Equity Shares: Issued to employees or directors for their contribution.
  

Preference shares provide shareholders with a fixed dividend and priority over equity shareholders in case of dividend distribution and capital repayment during liquidation. However, they typically do not come with voting rights.

Key Features of Preference Shares

• Fixed Dividend: Preference shareholders are entitled to a fixed dividend, but only if the company has distributable profits and declares a dividend.
  

• Priority in Payments: Preference shareholders are paid before equity shareholders.
  

• Limited Voting Rights: Usually, they do not have voting rights unless dividend is unpaid for a specified period.
  

• Capital Repayment: In case of winding up, preference shareholders are repaid before equity holders.
  

• Convertibility: Some preference shares can be converted into equity shares.
  

Types of Preference Shares

Preference shares offer fixed returns and come with varied features that influence how dividends and rights are handled. Understanding the different types can help you assess their suitability for your investment goals:

• Cumulative: Unpaid dividends accumulate and are paid in the future.
  

• Non-Cumulative: Unpaid dividends do not accumulate.
  

• Convertible: Can be converted into equity shares.
  

• Non-Convertible: Cannot be converted into equity shares.
  

• Redeemable: Can be repurchased by the company after a fixed period.
  

• Participating: Eligible for additional profits after dividends are paid to equity shareholders.
  

• Non-Participating: Not entitled to any surplus profits.

Equity and preference shares differ in terms of rights, returns, and risk exposure. A side-by-side comparison can help investors choose the option that aligns with their financial goals and risk appetite. Below is a detailed breakdown:

Key Differences

Consider two investors: Ramesh and Suresh. Both have invested in the same company, XYZ Ltd. Ramesh holds equity shares, while Suresh holds preference shares.

At the end of the financial year, XYZ Ltd. reports profits. The management decides to reinvest these profits into business expansion rather than distribute dividends to equity shareholders. As a result, Ramesh does not receive any dividend because equity shareholders receive dividends only when declared by the company.

Suresh, on the other hand, receives a fixed 6% dividend on his preference shares, as per the terms of issue. Despite not having a say in company decisions, he benefits from predictable income.

Later, the company conducts its Annual General Meeting to elect new board members. Ramesh, being an equity shareholder, is eligible to vote and participate in key company decisions. Suresh, however, does not have voting rights and hence, cannot vote on such matters.

This example highlights the core differences: equity shareholders have ownership benefits including voting rights and variable returns, while preference shareholders enjoy priority in dividends and capital safety but with limited control over company affairs.

Both equity and preference shares serve specific roles in a company’s financing strategy:

• Equity Shares help raise long-term risk capital without the obligation of repayment.
  

• Preference Shares offer hybrid benefits of equity and debt, allowing companies to raise funds with lower dilution of control.

• Equity Shares: Gains are subject to capital gains tax. Dividends above a certain threshold may also be taxable.
  

• Preference Shares: Fixed dividends are treated as income. Redemption may have tax implications depending on the structure.

• Bonus/Stock Splits: Usually apply to equity shareholders.
  

• Buybacks: Applicable to both, depending on company policy.
  

• Winding-Up: Preference shareholders are prioritised over equity shareholders.

Equity and preference shares each have unique characteristics that appeal to different types of investors.Equity shares may suit investors seeking capital appreciation and participation in company decisions, while preference shares may appeal to those prioritising stable returns. Understanding these differences helps build a diversified and risk-balanced investment portfolio.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

• Securities and Exchange Board of India (SEBI) – www.sebi.gov.in
  

• Ministry of Corporate Affairs – www.mca.gov.in
  

• NSE India – www.nseindia.com
  

• BSE India – www.bseindia.com
  

• Income Tax Department – www.incometax.gov.in