When a company issues shares, a part of its ownership is offered for sale. So when you buy shares of a company, you are actually becoming part-owners of the company in proportion to your shareholding. For example, if a company offers 1 lakh shares and you buy 10,000 shares, it means you now own a 10% stake in the company.
There are essentially two types of shares that companies usually offer – equity shares and preference shares. Although both these types of shares offer investors ownership in the company, they are different from one another. What is the difference between equity shares and preference shares?
Let’s explore the difference between equity share and preference share. But, before we get to that, let’s look at a brief overview of equity share and preference share.
This article covers:
- What are equity shares?
- Types of equity shares
- What are preference shares?
- Types of preference shares
- Difference between equity and preference shares
What are equity shares?
Equity shares are also called ordinary shares of a company. They cannot be redeemed and investors own them in perpetuity – they can only trade them with other investors. This translates as a source for long-term income generation for companies. If the company winds up its business, the equity share capital is liquidated and the shareholders are paid off, provided the company has sufficient assets for the same.
Equity shares give shareholders ownership of the company as well as voting rights at board meetings. Equity shareholders also enjoy the profits earned by the company in the form of dividend payments. When the company is listed on the markets, the equity shares are traded on the stock exchange. For privately held companies, however, the shares are owned by few individuals and not issued for public subscription.
Types of equity shares
Equity shares issued by companies are of many types. Some of the prominent are:
Authorized share capital
It is the maximum share capital that a company is allowed to issue for raising funds. A part of the authorized share capital may remain unissued.
Issued share capital
Issued share capital denotes the share capital issued by the company to raise funds.
Subscribed share capital
Out of the issued share capital, the proportion of capital that is purchased by investors is called subscribed share capital. For example, if the company issues 1 lakh shares and investors subscribe to 90,000 shares, the subscribed share capital would be calculated with 90,000 shares.
Paid-up share capital
The amount of share capital that is received by the company in exchange for the shares of the company is called the paid-up share capital.
Bonus shares are additional shares issued by the company to its existing shareholders, free of cost. Bonus shares are, usually, issued to reward investors with additional shares rather than in dividends when the company wishes to capitalise its earnings.
Shares issued to existing shareholders at a specified price, before they are offered to the common public. A rights issue allows existing shareholders to buy equity shares of a company at a discounted price before the shares are made public.
Sweat equity shares
Sweat equity shares are usually offered by start-ups to reward their employees for their efforts in growing the company. The opportunity of stock ownership helps companies retain talented employees.
What are preference shares?
Preference shares are a type of shares issued by a company to its shareholders before it is offered to the general public, that comes with some special advantages such as a higher claim on the earnings and assets of the company. Preference shares get precedence when it comes to dividend payments and paying back the shareholders at the time of winding up. The name is ascribed to this feature.
Preference shareholders, usually, do not get a voting right. However, they enjoy guaranteed dividend payments that common stockholders do not receive (it is management’s decision whether to issue dividends or not to equity holders).
Types of preference shares
Like equity shares, preference shares also come in different types. Here’s a list of the popular forms:
Convertible preference shares
Preference shares that are converted to equity shares on a specified date and at a specified rate are called convertible preference shares.
Non-convertible preference shares
Shares that remain preference shares throughout the tenure of the company are called non-convertible preference shares.
Participating preference shares
Shares that receive a part of the profits earned by the company, besides the guaranteed dividend, are called participating preference shares. Owners of such shares also enjoy voting rights on specific matters.
Non-participating preference shares
Shares that only earn a fixed dividend and not any surplus earned by the company are called non-participating preference shares.
Redeemable preference shares
Shares with a fixed maturity date are called redeemable preference shares. The company buys back such shares on maturity, after which, shareholders stop owning a stake in the company.
Non-redeemable preference shares
Shares that cannot be redeemed and continue throughout the lifetime of the company are called non-redeemable preference shares.
Cumulative preference shares
In the case of cumulative preference shares, the guaranteed dividend keeps adding up in arrears if the company makes losses. Once the company earns a profit, the arrears are paid to the shareholders.
Non-cumulative preference shares
These shares do not pay dividends in arrears if they are outstanding in the case of losses.
Adjustable preference shares
Under adjustable preference shares, the dividend amount is not fixed. It depends on the market performance of the company.
Difference between equity shares and preference shares
Now that you know the meaning and types of equity shares and preference shares, let’s delve into the differences between the two major types of equity shares issued by companies. The following table highlights the main difference between equity and preference shares:
Comparative difference between equity and preference shares
|Differentiating factors||Equity shares||Preference shares|
|Dividend payment||The dividend rate is not guaranteed. It depends on the profits earned by the company after all the liabilities have been paid off. Equity shareholders rank below preference shareholders when it comes to dividend payments||Preference shareholders usually receive a fixed rate of dividend irrespective of the profits earned by the company. In the case of dividend payment, preference shareholders are given priority. After the preference shareholders are paid dividends, the remaining profit is distributed among equity shareholders|
|Capital payment on liquidation||At the time of winding up, equity shareholders are paid last, after the liabilities and preference shareholders are paid off||When the company winds up, preference shareholders take precedence over equity shareholders in the payment of capital. They are paid off first after the payment of other liabilities. Then, if the company has surplus assets, equity shareholders are paid|
|Voting rights||Equity shareholders enjoy voting rights in company matters||Voting rights are not usually allowed under preference shares|
|Bonus shares||Equity shareholders can enjoy bonus shares if they are issued by the company||No bonus shares are issued to preference shareholders|
|Mandatory issuance||Equity shares are a must if a company is looking to raise finance through share capital||The company doesn’t need to issue preference shares|
|Conversion||Equity shares cannot be converted to preference shares||Convertible preference shares can be converted to equity shares|
|Redemption||They are irredeemable||Preference shares can be redeemable|
|Arrears of dividend||If no dividend is paid under equity shares, there would be no provision of paying the dividend in that financial year||If the dividend is not paid, it gets accumulated in arrears. It is important to pay dividends to preference shareholders in subsequent financial years|
|Underlying risk||Since dividends are not fixed and they get the last preference for capital repayment, equity shares carry a higher degree of risk||They are safer since the dividend rate is usually fixed and they get preferential rights over the company’s assets|
|Tradability||Can be traded on stock exchanges||Cannot be traded|
|Participation in company management||Have a say or participation in the management of the company||Have no say or participation in the management of the company|
So, understand the difference between equity share and preference share before you start purchasing shares. Both these issues are considerably different from one another with a different risk-return profile. Know what they are and what they entail so that the next time you glance at the balance sheet of a company, you can understand the composition of its share capital.