Learn the Difference Between Equity Share and Preference Share
Many investors aren’t aware of the difference between equity share and preference share. While investing in the stock market, one of the critical decisions you’ll have to make is to choose between equity and preference shares.
Both equity and preference shares are the type of securities that are issued by companies. However, they differ in ownership rights and the benefits they offer to shareholders. As an investor, understanding the difference between equity and preference shares is crucial in making an informed investment decision.
In this blog, we will take a closer look at the difference between equity share and preference share, exploring their features, benefits, and risks, so you can decide which is right for you.
What are Equity Shares?
When investing in the share market, equity shares are a popular option for investors.
Equity shares represent ownership in a company, giving investors a stake in the company’s profits and assets. As an equity shareholder, you become a part-owner of the company and are entitled to a portion of its profits.
Additionally, equity shares offer various benefits to investors, including potential dividends and voting rights. These benefits are the features of equity shares.
There are several reasons why companies issue equity shares. However, raising capital to fund their business activities always comes first. Apart from this, issuing equity shares help companies diversify their sources of funding. Therefore, companies can raise funds from a wider pool of investors instead of relying solely on loans or credit.
Moreover, issuing equity shares can help companies build their brand and reputation. By selling shares to the public, companies can increase their visibility and gain a larger following of investors and supporters. Now that the meaning of equity share capital has been established, let us look at it’s main benefits.
Main Benefits of Investing in Equity Shares
Voting Rights
One of the main benefits of equity shares is the right to vote on certain company decisions. Shareholders may be able to vote on matters such as the election of the board of directors or major business decisions. The number of votes each shareholder receives is typically determined by the number of shares they own.
Ownership
When investors purchase equity shares, they become part-owners of the company. This means they have a say in the company’s decisions and can benefit from its success.
Risk & Return on Equity Shares
Equity shares can potentially provide higher returns than other investments over the long term. This is because the value of equity shares can increase over time as the company grows and generates higher profits.
In addition, companies may distribute a portion of their profits to equity shareholders as dividends, which can provide a regular income stream. However, equity shareholders receive the dividends only after all the other claims on the company’s assets and income have been settled. Also, the dividend amount for equity shareholders is not fixed.
Moreover, investing in equity shares carries a higher level of risk than other types of investments. This is because the value of equity shares can fluctuate significantly based on changes in the company’s financial performance, market conditions, and other factors. Furthermore, equity shareholders are the last in line to receive payouts in the event of a company’s financial distress or bankruptcy.
Types of Equity Shares
The following are the different types of equity shares:
- Bonus Equity shares
- Right Shares
- Sweat Equity Shares
- Authorized Share Capital
- Paid-up Share Capital
- Issued Share Capital
- Subscribed Share Capital
Now, let’s understand the meaning, benefits, associated risks, and types of preference shares.
What are Preference Shares?
Preference shares, also known as preferred shareholder shares or simply “prefs,” are a type of ownership stake in a company that comes with specific rights and privileges.
These shares are a type of equity security that gives shareholders a higher claim on the company’s assets and earnings than common shareholders. They are called “preference” shares because they often have priority over common shares in terms of dividend payouts and liquidation proceeds. The features of preference shares include dividend payouts and dividend preference.
Companies issue preference shares to raise capital without diluting their ownership or control.
Another reason why companies issue preference shares is to improve their debt-to-equity ratio. Since preference shares are considered a form of hybrid security, they are often viewed as a mix of debt and equity. This means that companies can issue preference shares to raise funds while maintaining a healthy balance sheet that shows a lower debt-to-equity ratio. Now that the meaning of preference shares has been established, let us look at its main benefits.
Main Benefits of Preference Shares
Fixed & Stable Dividend Payouts
Preference shares offer fixed dividend payments that are typically higher than what is offered on common equity shares. Hence, preference shareholders get a set amount of money each year, regardless of how well the company performs.
Priority in Dividend Payouts
Another significant benefit of preference shares is that preference shareholders enjoy priority in dividend payouts. In the event of a company’s financial distress or bankruptcy, preference shareholders have priority in receiving dividend payouts before equity shareholders.
Risk & Return on Preference Shares
Investing in preference shares is like having a steady, reliable companion. While they may not be as flashy as their equity share counterparts, they offer a dependable source of income in the form of fixed dividend payments.
However, just like any investment, there are some risks to consider. Interest rates, inflation, and credit risk can all impact the value of preference shares, so it’s important to do your due diligence before diving in.
Moreover, preference shares won’t make your heart race with excitement, like the potential for high growth in equity shares. But they offer a level of comfort in their stability and predictability.
Types of Preference Share
- Cumulative Preference Shares
- Participating Preference Shares
- Convertible Preference Shares
- Non-Convertible Preference Shares
- Redeemable Preference Shares
The main differences between equity share and preference share are the dividend payouts, voting rights, risk and return, and types of shares. But there are some other differences as well that you should know about. So, let’s check them out!
Difference Between Equity Share and Preference Share – Equity Shares vs Preference Shares
Now that we know what is equity share and preference shares, let’s explore their key differences. The differences between equity shares and preference shares, or you can say common stock vs preferred stock are as follows:
| Basis | Equity Shares | Preference Shares |
| Meaning | A type of ownership security that represents a portion of a company’s assets and earnings. | A type of ownership security that typically offers fixed dividend payments and does not give shareholders voting rights. |
| Voting Rights | Equity shareholders have voting rights. | Preference shareholders do not have voting rights. |
| Dividend Payouts | Equity shareholders receive dividends after paying all the other liabilities. | Preference shareholders are given dividends on a priority basis. |
| Rate of Dividend | The rate of dividend is not fixed. | Preference shareholders have a fixed dividend rate. |
| Capital Repayment | It is paid after paying all the liabilities. | It is repaid before paying to equity shareholders. |
| Bonus Shares | Equity shareholders receive bonus shares in proportion to their existing holdings. | Preference shareholders may not be entitled to bonus shares unless specifically stated. |
| Redemption | Equity shares can not be redeemed. | Preference shares can be redeemed. |
| Convertibility | Equity shares can not be converted. | Preference shares can be converted into equity shares. |
| Suitable for | Equity shares are suitable for risk-taking investors. | Preference shares are suitable for risk-averse investors. |
| Types of Equity Shares and Preference Shares | Bonus shares, sweat shares, right shares, etc. | Convertible, non-convertible, redeemable, non-redeemable, etc. |
Equity vs Preference Shares – The Basics of Investing
To invest effectively in these shares, you must have a strong grasp of the stock market. Without this knowledge, the risk of financial loss is high.
Keep in mind two key principles:
- Buy shares when the market is down, as prices are generally lower, and
- Sell when it’s up, as share prices tend to be higher.
Long-term investments typically yield better returns.
Mutual funds might be a safer choice compared to individual stocks, for beginners, due to lower risk. Be cautious of seemingly lucrative advice; high-return investments often come with high risks.
If you’re not interested in mutual funds, consider purchasing stocks during Initial Public Offers (IPOs) in the primary market. Thoroughly research any company before investing to minimize the risk of financial loss.
If direct purchasing isn’t available, create a Demat account through a broker to buy securities from companies listed on stock exchanges like NSE or BSE in the secondary market.
To Wrap It Up…
Both equity share capital and preference share capital have their own unique features and benefits. Equity shares offer voting rights and the potential for high returns but also have more risk and volatility. On the other hand, preference shares offer fixed dividend payments and greater stability but usually do not offer voting rights and have a lower potential for returns.
Therefore, as an investor, you should carefully consider your investment objectives, and risk tolerance, before making any investment decisions.
Moreover, if you want to build a low-cost, diversified portfolio, you may check out smallcase. Since smallcase has ready-made portfolios created by professionals, you can begin your investment journey from Day 1 itself.
FAQs
Preference shares have a higher price range, limiting access to medium and large investors. They allow preference shareholders to claim both arrears and current-year dividends, unlike equity shareholders.
Preference shares blend debt and equity traits, assuming equity risk without securing principal, while providing fixed interest through dividends.
Preference shareholders receive higher priority in dividend payments, with rates fluctuating based on earnings and remaining fixed. They also qualify for bonuses on existing holdings. This is the preference shares and equity shares difference. It makes choosing between preference and equity shares easier.
Divergent opinions exist regarding the conversion of equity into preference shares. The prevailing view is that such conversion may result in capital extinguishment, necessitating capital reduction and court approval.
Convertible preference shares can convert to equity shares, while non-convertible preference shares remain unable to convert.
Equity shareholders own the company, while preference shareholders enjoy priority in receiving profits and assets, including dividends. On the other hand, equity shares get last priority in dividends.
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