Meaning of Equity Shares and Preference Shares
When a company needs to raise capital, it can do so by issuing shares to investors. These shares represent ownership in the company and can be broadly categorised into equity shares and preference shares. Equity shareholders have voting rights and share in the company’s profits, while preference shareholders receive fixed dividends and priority in capital repayment but lack voting rights. Understanding the differences between these two types of shares is essential for investors looking to make informed financial decisions.
Equity Shares
Equity Share Capital is the money raised by a company by issuing equity (ordinary) shares to investors. These investors become shareholders with ownership and voting rights, allowing them to participate in management decisions. The capital raised through equity shares remains with the company and can only be claimed back if the company shuts down. Additionally, equity shareholders have voting rights in the selection of the company’s management.
Preference Shares
Preference Share Capital is the money raised by a company by issuing preference shares, which gives shareholders the right to receive dividends before equity shareholders. While preference shareholders are part owners of the company, they do not have voting rights in management decisions. They are entitled to a fixed dividend rate and have the right to claim repayment of capital if the company dissolves.
Now that we have learnt about Equity and Preference Shares let’s look at the Difference between Equity Shares and Preference Shares.
What is the Difference Between Equity Shares and Preference Shares
Types of Equity Shares and Preference Shares
Types of Equity Shares
1. Authorized Share Capital – The maximum amount of share capital a company is allowed to issue.
2. Issued Share Capital – The portion of authorized capital that has been issued to shareholders.
3. Subscribed Share Capital – The portion of issued capital that shareholders have agreed to take up.
4. Paid-up Share Capital – The amount of capital shareholders have paid for their shares.
5. Rights Share – Shares offered to existing shareholders to buy additional shares at a discounted price.
6. Bonus Share – Shares issued to existing shareholders free of cost, often from company profits.
7. Sweat Equity Share – Shares given to employees or directors for their services instead of cash payment.
Types of Preference Shares
1. Cumulative Preference Shares – Shareholders are entitled to dividends from previous years if they were not paid in the current year.
2. Participating Preference Shares – Shareholders can receive additional dividends beyond the fixed rate, depending on company profits.
3. Redeemable Preference Shares – Shares that the company can buy back at a later date.
4. Convertible Preference Shares – These shares can be converted into equity shares after a certain period.
5. Non-Cumulative Preference Shares – Dividends are not carried over if not paid in a given year.
6. Non-Participating Preference Shares – Shareholders only receive the fixed dividend without the option of receiving additional profits.
7. Non-Redeemable Preference Shares – These shares cannot be bought back by the company before the maturity date.
8. Non-Convertible Preference Shares – These shares cannot be converted into equity shares.
Conclusion
Equity shares and preference shares are two important types of capital used by companies to raise funds. Equity shares offer ownership and voting rights but come with higher risk, while preference shares provide a fixed dividend and priority in dividends and asset claims, but without voting rights. Both types of shares have different features, and companies use them based on their financing needs and goals.
FAQs on Difference Between Equity Shares and Preference Shares
1. What is the main difference between equity shares and preference shares regarding dividend payments?
The primary difference lies in the nature and priority of dividends. Preference shareholders receive a fixed rate of dividend, and they must be paid before any dividend is paid to equity shareholders. In contrast, equity shareholders receive dividends that are not fixed and depend on the company's profits, paid only after all obligations, including preference dividends, have been met.
2. Who are considered the real owners of a company: equity or preference shareholders?
Equity shareholders are considered the real owners of a company. This is because they bear the ultimate financial risk and possess voting rights, which allow them to participate in the company's management and decision-making processes. Preference shareholders are also part-owners but have limited rights and are more comparable to creditors in terms of receiving a fixed return.
3. What are the voting rights of equity shareholders versus preference shareholders?
Equity shareholders have full voting rights on all matters concerning the company, allowing them to elect the board of directors and influence major decisions. Preference shareholders generally do not have voting rights in the normal course of business. They may only get voting rights under specific circumstances, such as when their dividends are in arrears for a specified period, as per the CBSE 2025-26 syllabus guidelines.
4. In a company's liquidation, who gets paid first, equity or preference shareholders?
During the winding up of a company, preference shareholders have a preferential right to the repayment of their capital over equity shareholders. They are paid after the company's creditors but before anything is distributed to equity shareholders. Equity shareholders are the last to be paid and receive only the residual amount, if any.
5. Can a preference share be converted into an equity share?
Yes, but only if they are issued as convertible preference shares. These shares come with an option for the holder to convert them into a pre-determined number of equity shares after a specified period. This feature must be included in the terms of issue when the shares are offered, as it is not a default right for all preference shares.
6. Why would a company choose to issue preference shares instead of equity shares?
A company might issue preference shares for several strategic reasons:
- To raise capital without diluting the control of existing equity shareholders, as preference shares typically don't carry voting rights.
- To appeal to cautious investors by offering a fixed dividend, which can be easier to manage than fluctuating dividends.
- To avoid the permanent burden of interest payments associated with debt financing like debentures, as dividends are paid out of profits.
7. From an investor's point of view, which is a better investment: equity shares or preference shares?
The "better" investment depends entirely on the investor's risk appetite and financial goals.
- Equity shares are suitable for investors with a high-risk tolerance seeking potentially high returns through capital appreciation and profit-linked dividends.
- Preference shares are ideal for risk-averse investors who prioritise a stable, fixed income and the safety of their capital over high growth potential.
8. How do equity shares, preference shares, and debentures differ as sources of finance?
These three instruments represent different forms of financing:
- Equity & Preference Shares represent owned capital. Shareholders are owners of the company.
- Debentures represent borrowed capital (debt). Debenture holders are creditors of the company, not owners.
9. What are 'cumulative' and 'non-cumulative' preference shares, and how do they impact an investor?
These terms define how unpaid dividends are treated and significantly affect investor security:
- Cumulative Preference Shares: If a company skips a dividend payment, the unpaid amount (arrears) accumulates. It must be paid in full in subsequent years before any dividend is paid to equity shareholders. This provides greater security to the investor.
- Non-Cumulative Preference Shares: If a dividend is not declared in a particular year, it lapses and is lost forever. The investor has no claim on it in the future, making this type riskier.
10. If equity shares carry higher risk, why are they so popular among investors?
Equity shares are popular because higher risk is linked to the potential for higher returns, which are not capped. Investors are attracted by:
- Capital Appreciation: The market price of the share can increase significantly as the company grows and prospers.
- Ownership and Control: Investors get a say in the company's management through voting rights.
- Bonus Shares and Rights Issues: Profitable companies may issue additional shares to existing equity shareholders, increasing their wealth.
