Equity and preference shares are common types of investments in the stock market. Equity shares generally represent ownership in a company and typically offer voting rights and the potential for high returns.
On the other hand, preference shares come with specific privileges like fixed dividends and priority during liquidation, but often without voting rights.
Understanding the differences between these two types of shares is crucial for investors, as it impacts their rights, returns, and risk levels.
In this article, we'll list the contrast between equity and preference shares to help you make informed decisions about your investment portfolios. But, before that let's understand both equity and preference shares.
Equity and preference shares are common types of investments in the stock market. Equity shares generally represent ownership in a company and typically offer voting rights and the potential for high returns. On the other hand, preference shares come with specific privileges like fixed dividends and priority during liquidation, but often without voting rights. Understanding the differences between these two types of shares is crucial for investors, as it impacts their rights, returns, and risk levels. In this article, we'll list the contrast between equity and preference shares to help you make informed decisions about your investment portfolios. But, before that let's understand both equity and preference shares.
Equity shares, is also known as ordinary shares, represent ownership in a company. When you buy equity shares, you become a partial owner of the company in respect to how much shares you own and have a claim on its assets and profits.
Equity shareholders typically have voting rights, allowing them to participate in key decisions of the company, such as electing the board of directors.
Additionally, equity shareholders have the potential to earn dividends i.e., portion of the company's profits distributed to shareholders.
These shares are considered riskier than preference shares but offer the potential for higher returns if the company performs well.
There are various types of equity shares that companies can issue, each with its own characteristics. Some common types include:
Ordinary shares are the basic type of stock that individuals can buy in a company. When you own ordinary shares, you become a part-owner of the company and have the right to vote on company matters at shareholder meetings. You also have the potential to receive dividends, which are a share of the company's profits. However, dividend payments are not guaranteed and depend on the company's financial performance.
Preference shares have privileges over ordinary shares, such as receiving fixed dividends before ordinary shareholders. Unlike ordinary shares, preference shares often lack voting rights or have limited voting rights. They offer investors a predetermined dividend payment but generally do not allow them to participate in the company's profits beyond the fixed rate. Preference shares can be divided into two categories: participating and non-participating. When an investor buys participating preference shares, they are entitled to receive a specified portion of the company's profits, as well as bonus returns if the company performs well in a particular financial year. However, non-participating preference shareholders do not receive any such benefits. Also, if the company dissolves or ends its business, preference shareholders are among the first to receive repayment of their capital.
Bonus shares are given to existing shareholders for free, based on the company's profits or reserves. They don't require shareholders to pay any extra money. Instead, the company uses its accumulated earnings to issue these additional shares. While bonus shares don't bring in new capital, they increase the total number of shares outstanding. This can dilute the ownership percentage of existing shareholders, but it's a way for companies to reward shareholders and increase liquidity without affecting their cash reserves.
When a company wants to issue more shares to its current shareholders, it offers them the opportunity to buy these new shares first at a lower price compared to the market rate. This is called a rights issue. Shareholders have the right, but not the obligation, to purchase these additional shares in proportion to their existing holdings. It's a way for the company to raise additional capital from its existing shareholders while giving them priority and maintaining their ownership stake.
Sweat equity shares are given to employees or directors as a form of reward for their contributions to a company's growth. Unlike regular shares, they are issued at a discount or for free. However, they come with certain conditions and restrictions outlined in the Companies Act 2013. These shares allow individuals to become partial owners of the company they work for, providing them with potential financial benefits based on the company's performance.
Preference shares is type of investment that gives shareholders certain benefits, like getting paid dividends before other shareholders. They are called "preference" shares because they have priority over common shares when it comes to receiving dividends and getting their money back if the company is sold or goes bankrupt.
Preference shares usually don't come with voting rights, meaning shareholders can't vote on company decisions like common shareholders can.
They are a popular choice for investors who want a steady income from dividends and a higher level of security compared to common shares.
Preference shares come in various types, each offering different rights and privileges to the shareholders. Some common types of preference shares include:
Cumulative Preference Shares ensure that if the company can't pay dividends for one year, you'll receive them in later years. Let's say you own these shares, and the company misses a dividend payment due to financial difficulties.
With cumulative preference shares, you're entitled to collect those missed dividends in the future when the company is in a better financial position.
This feature provides you with a sense of security, knowing that you won't permanently lose out on your dividend payments if there's a temporary setback.
Non-cumulative preference shares don't guarantee unpaid dividends from one year to the next. If the company doesn't pay dividends in a specific year, shareholders with these shares won't be able to claim those missed dividends in future years.
Essentially, it's a "use it or lose it" scenario. Unlike cumulative preference shares, there's no accumulation of unpaid dividends over time.
So, if the company doesn't distribute dividends in a particular year, shareholders with non-cumulative preference shares won't receive compensation for that missed payout later.
Participating in preference shares gives you extra dividends if a company's profits exceed a set level. If the company does well and earns more than expected, you'll receive additional dividends on top of the fixed rate. It's like getting a bonus when things go well for the company.
However, if profits don't reach the threshold, you'll still receive the fixed rate of dividends, ensuring a consistent income regardless of the company's performance beyond a certain point.
Non-participating preference shares mean you only get a fixed dividend rate. Unlike participating preference shares, where you can get extra dividends if the company's profits surpass a specific level, non-participating shares don't offer this opportunity. With these shares, you receive dividends only up to the agreed-upon fixed rate.
So, while they provide stability with guaranteed dividends, you won't benefit from any additional profits the company may generate beyond the fixed rate.
Convertible preference shares allow you to exchange them for a set number of regular company shares after a specific time.
For example, you might have the option to convert each preference share into two ordinary shares after three years.
This feature gives you flexibility because if the company's performance improves, you can benefit by converting your preference shares into regular shares, which may have a higher potential for growth or dividend payouts.
Redeemable preference shares can be repurchased by the company after a set period or on a specified date. This means that the company has the option to buy back these shares from shareholders at a predetermined price.
It provides flexibility to the company in managing its capital structure and can be advantageous for shareholders as they may receive the redemption price along with any accrued dividends.
However, it's important to note that redemption is subject to the terms outlined in the share agreement.
Adjustable-rate preference shares have a flexible dividend rate that can change depending on market conditions or predefined factors.
Unlike fixed-rate preference shares, where the dividend rate remains constant, adjustable-rate shares allow for adjustments over time. This can provide investors with potential benefits if market conditions improve, as they may receive higher dividends.
However, it also means that dividends could decrease if market conditions worsen, so you should be aware of the risks involved in this type of investment.
Now that you understand what equity shares and preference shares are let's explore the main differences between them. Here's a simple table that shows the key difference between preference shares and equity shares:
| Feature | Equity Shares | Preference Shares |
| Ownership | Owners are shareholders who have voting rights and ownership in the company. | Owners are shareholders who do not usually have voting rights but have priority in receiving dividends and assets in case of liquidation. |
| Dividend | Dividend payment is not fixed and depends on the company's profitability and board decision. | Dividend payment is usually fixed and paid before equity shareholders receive dividends. |
| Voting Rights | Equity shareholders have voting rights and can influence company decisions. | Generally, they do not have voting rights, or if they do, they may be limited. |
| Risk | Equity shareholders bear higher risk as they are the last to receive payments in case of liquidation. | Preference shareholders have lower risk as they have priority in receiving payments and dividends. |
| Redemption | Equity shares cannot be redeemed by the company. | Preference shares may be redeemable or irredeemable, depending on the terms of issuance. |
| Conversion | Equity shares cannot usually be converted into preference shares. | Preference shares may sometimes be convertible into equity shares. |
| Rate of Return | Equity investors have the opportunity to achieve increased returns through the appreciation of capital. | Preference shareholders receive fixed dividends but usually do not benefit from capital appreciation. |
| Priority | Equity shareholders have no priority in receiving dividends or assets during liquidation. | Preference shareholders have priority in terms of receiving dividends and during liquidation but are subordinate to debt holders. |
It is important to understand the difference between equity and preference shares before investing. They have different risk-return profiles, so knowing what they involve is essential. Next time you look at a company's balance sheet, understanding its share capital composition will be easier.
To make informed decisions, learn about these shares and their implications. Consider using Bigul trading platform for your investment needs.
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