The financial world consists of both the debt market as well as the equity market and every corporate needs to raise capital by issuing shares, which could be in the form of equity shares, preference shares, etc. However, the prime reason for one to invest in the volatile share market over its debt counterparts is the sheer joy of overperformance.
So, when you consider long-term investment, equity investments turn out to be one of the most profitable ones. Sure, there is the risk of prices going high enough to bring an ear-to-ear smile and low enough to make you regret your decisions at times. But over a considerable period, you could walk away with good returns.
When we discuss shares, there are two types of shares that one can choose between, equity shares and preference shares. But before you can start investing, the most obvious question to ask would be what are equity shares and preference shares.
Equity shares and preference shares are quite similar, yet different in the way they function and offer you returns. When you own equity shares of a company, the dividends are subject to how the company is performing. And at times, you might not even receive any dividends.
This is one major difference between equity shares and preference shares. With preference shares, the company is bound to pay you dividends, since the amount is fixed but not with equity shares.
- Equity Shares
When you hear the word shares, people almost always refer to equity shares or ordinary shares. With equity shares, a company offers you partial ownership and thus, involves a lot of business risk.
The members, who own equity shares, also acquire the right to vote for critical decisions in the company. These decisions may include electing a new leader, acquisition, merger, etc. And they play a crucial role in raising capital for the company. Equity capital forms the basic foundation of the company and its creditworthiness.
The dividends or payouts to equity shareholders predominantly depend on the earnings of the company. Once the company has settled all other claims and expenses, it will pay its equity shareholders.
- Preference Shares
Between equity shares and preference shares, it is the latter that offers a certain source of income. With preference shares, a company promises its shareholders a fixed amount as dividend. And the preference shares take precedence over ordinary shares or equity shares.
They also have an edge over equity shareholders when it comes to repaying of capital. Since the rate of dividends is fixed, it is usually compared with debentures.
Salient Differences between equity shares and preference shares
Now that we are aware of the definition of equity shares and preference shares, we can delve into the major differences. Here are some of the key differences when it comes down to equity shares vs preference shares.
- Preference shares have specific rights over ordinary shares or equity shares of a company.
- Preference shareholders do not have any rights when it comes to voting, whereas equity shareholders do. However, under a few circumstances, preference shareholders can gain the right to vote. For instance, if there hasn’t been dividend payment in over two years.
- Preference shareholders do not reserve any claims to bonus shares, while one of the biggest merits of equity shares includes them having access to bonuses.
- Preference shareholders have the right to receive dividends, but equity shareholders do not have any such rights. A dividend is paid out only if the company makes a profit to distribute.
- Also, in a given year, if a dividend is not paid out to preference shareholders, the same would be accumulated and needs to be paid out later. However, the same is not true for equity shareholders. If a dividend is not declared for equity shareholders, the same does not accrue.
- One of the limitations of preference shares is that shareholders do not have any claims in the management of the company, whereas equity shareholders do.
- Preference shareholders can convert their shares to equity shares, but the reverse is not possible.
Other than the salient differences, there is some outright difference between equity shares and preference shares which are worth mentioning. Here are some additional equity shares vs preference shares pointers that you should be aware of.
- The basic description
One crucial equity shares and preference shares’ difference is that equity shares are the foundation of a company, while preference shares give shareholders an edge over ordinary shares. It is offered to banks or large corporates when the company needs funds.
It is one of the biggest merits of preference shares that a company receives funds whenever additional capital is required.
- The rate of dividend
The dividend paying rates of equity shares and preference shares may differ a bit. While there isn’t any fixed rate for paying dividends to equity shareholders, preference shareholders do receive dividends at a fixed rate, which is predefined and can be a nominal value of the share price.The rate of dividend for equity shareholders is decided by the Board of Directors after evaluating the company’s performance in the previous financial year.
- Issuance of shares
It is mandatory to issue equity shares of a company to go public while issuing preference shares is not mandatory under the Company’s Act 2013.
You can easily trade equity shares in the capital market, whereas you cannot trade preference shares. This makes them less liquid as compared to equity shares. Thus, the preference shares do not see any price appreciation or depreciation as the equity shares do. Investors do have the option to sell back the preference shares to the company.
Another equity shares and preference shares difference come in the form of types. Since equity shares do not have any type, they are normally known as ordinary shares. On the other hand, the different types of Preference Shares include non-participatory or participatory, cumulative or non-cumulative, convertible or non-convertible and so on.
The low cost of the equity shares makes them accessible by small investors. On the contrary, the higher price tags on the preference shares make them ideal for medium to large investors.
In the event of liquidation, the preference shareholders will have the first right to receive any kind of payment after the company’s creditors are paid. While equity shareholders have rights on the assets of the company once all the pending payments are complete.
One of the limitations of equity shares is that a company is not liable to repay the equity shares to its holders, whereas they must repay their preference shareholders.
As discussed in the beginning, equity shares and preference shares are similar yet quite different. Equity shares and preference shares both allow you to own a piece of the company but in various other aspects. So, preference shares are a mix of equity shares and debentures.
The crux of the story is that there are many choices available to invest. However, investing should be done after understanding the instruments and, as per your goals. At IndiaNivesh, we use extensive research to help you achieve your financial goals. Equity investing requires in-depth understanding, analysis, and periodic reviewing. Our team uses one of the best proprietary equity research to make your investment a fruitful one.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.