Difference Between Equity Share And Preference Share

For a layman, the difference between equity share and preference share may be ambiguous. Both of them are instruments of investment, however, they differ in their nature. Apart from voting rights and distribution of dividends, equity and preference shares have many key differences among them. We have discussed major differences between Equity Share and Preference Share.

What Is Equity Share?

Equity shares are the shares that do not enjoy any preferential treatment or right in the matter of payment of dividends or repayment of capital in a company. These cover all those shares that do not preference shares.

Equity share-holders do not enjoy a fixed dividend on the money they invest in a company. Rather, they enjoy a share in the distributable net profits of a company. A company pays equity shares only after all the rights of preference shares have been settled. Unlike preference shares, the returns on equity shares depend on the performance of the company.

Types Of Equity Share

Though the balance sheet of a company mentions equity share as liability, it provides the capital to raise and run the company. We classify equity shares:

• Those with voting rights, or
• Equity shares that come with differential rights as to voting, dividend, or otherwise.

What Are Preference Shares?

Preference Shares or Preference Share Capital comes with a fixed rate of dividend. Hence, they have some sort of benefit over equity shares in this case. However, preference shares lack voting rights. By definition, a preference share must fulfill the following two requirements:

1. A company must assure a preference share-holder of a preferential dividend throughout the life of the company.
2. In the case of a winding-up of the company, a preferential share carries a preferential right over equity shares.

Generally, companies do not issue preference shares to retail investors. They issue them to institutional investors such as banks, NBFCs, and other such institutions.

We must also note that participating preference shares carry a defined right to take part in the surplus profit of a company. As per Section 55 of the Companies Act, 2013, a company cannot issue irredeemable preference shares if it is limited by shares.

Difference Between Equity Share And Preference Share

Following are the key differences between equity shares and preference shares:

• Meaning: We also know equity shares as ordinary shares. They have some percentage ownership in the company. Preference shares come with preferential rights.
• Dividend: equity share-holders do not have any preference in dividend payments. But a company always pays a dividend on the preference shares in preference to the equity shares. A company pays a dividend on equity shares only after the preference share-holder dividend has been fully paid.
• Rate of Dividend: With equity shares, the rate varies according to the company’s performance in the stock market and the net profit available. Preference shares always have a fixed rate/amount of dividend.
• Voting Rights: equity shares come with voting rights in the matters of the company. They can vote on all matters. Preference shareholders have very restricted or no voting rights.
• Bonus Shares: a company does not offer bonus shares to preference shareholders. But equity shareholders are entitled to receive such bonus shares.
• Capital Repayment & Liquidation: The preference share-holder always has preference over equity share-holder concerning the repayment of capital on winding-up.
• Investing Term: Equity shares are best for long-term financial goals. Preference shares are good for mid to long term financial goals.
• Redemption: Equity shares cannot be redeemed, but redeemable preference shares of a company are redeemed on expiry of a predefined period.
• Arrears: With cumulative preference share, the dividend not paid in a previous year is accumulated and paid fully. Until such arrears of dividends are paid to preference shareholders, a company does not pay a dividend to any equity shareholder.
• Risk Factor: risk-taking investors prefer equity shares and preference shares are good for risk-averse investors.
• Denomination: equity shares have a low denomination like Rs. 10/- etc. In the case of preference shares, they have higher denominations. Due to low denomination, equity shares are an attractive investment option for retail investors.
• Financial Burden: a company may or may not declare dividends on equity shares but it must mandatorily do so for preference shares. Hence, preference shares have a fixed repayment obligation from the issuing company.

Final Thoughts

After understanding the difference between equity share and preference share, we can conclude that both these shares benefit the investors differently. Low risk-profile investors prefer preference shares as a more attractive option of investment. Equity shares are associated with higher risk.

Hence, depending on one’s risk profile, tenure of investment, and financial goals, you can choose the investment option from equity vs preference shares.

Frequently Asked Questions