Difference between Equity and Preference Shares

The classification of the share market includes several types of securities. Two of them that are also among the most actively traded securities are equity shares and preference shares. Both types have been defined in Section 85 of the Indian Companies Act 1956. The main difference between equity shares and preference shares is the distribution of dividends to the shareholders. Equity shares offer ownership rights to the shareholders, whereas preference investments give a fixed return. This article will discuss the difference between equity and preference shares by understanding aspects like equity and preference share meaning, how they operate, benefits, and more.

Difference Between Equity and Preference Shares

The following breakdown explains the main difference between equity and preference shares by listing down all the important aspects.

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What Exactly are Equity Shares?

Equity shares represent a stake in a company, allowing investors to participate in its ownership. Companies issue these shares to raise capital for their business ventures. By purchasing equity shares, investors gain a proportionate interest in the organization. 

The equity shares provide benefits to the investors by offering a share of capital gains and the organization for collecting required capital. These kinds of shares can be acquired on a stock exchange. 

One significant aspect that individuals should understand is that equity shareholders possess voting rights, meaning they can vote on matters concerning the company. In addition to this, equity shareholders have the right to receive dividends. However, the amount of dividends that would be paid to investors will depend on how profitable the company is and how it decides to use the earnings.

Types of Equity Shares

Some common types of equity shares include the following. 

• Rights Shares: These are shares that are issued to a company's current shareholders at a reduced price. The minimum subscription requirements must be fulfilled by the company's shareholders.
• Employee Stock Options: It is a form of equity compensation that the business offers to its management and staff members. The business issues derivatives options over the equities rather than immediately issuing shares.
• Bonus Shares: These are extra shares that are part of the business's overall gains. The corporation gives its current shareholders these shares for free.
• Sweat Shares: These are given to the company's directors and staff at a discounted rate in exchange for non-cash consideration.

Features of Equity Shares

The following is the breakdown of several notable features of equity shares. 

• The shareholders have the right to vote and participate in strategic decisions affecting the company's operations.
• If the corporation suffers a loss, it does not cause suffering to the equity shareholders, due to limited accountability.
• Equity holders do not receive refunds from the organization (from which they purchased equity shares). Individuals who want to recover their investment must either enter the stock market, wait for the business to be liquidated, or exchange the stock.
• These shares are permitted to pay dividends to shareholders, but there is no guarantee of payment, and it may vary depending on the performance of the business.

What Exactly Are Preference Shares?

Preference shares grant their holders priority over common shareholders in terms of dividend payments and asset distribution. While preference shareholders possess similar ownership rights as equity shareholders, they do not have voting rights, except in matters directly affecting their preferential status. In the event of a company's liquidation, preference shareholders are entitled to a share of the net assets, with the specifics of their entitlements determined by the terms outlined in the security contracts.

Types of Preference Shares

Some of the common types of preference shares include the following. 

• Redeemable Preference Shares: The issuer of these shares may choose to redeem the shares at a price specified in the prospectus. 
• Irredeemable Preference Shares: These types of shares cannot be redeemed. The companies are not allowed to sell these shares to the general public.
• Cumulative Preference Shares: Shares with cumulative preference have all the rights and characteristics of regular preferential shares. This covers the right to dividend payments and the right to payments in the event of liquidation.
• Non-Cumulative Preference Shares: Shareholders of non-cumulative preference shares get a fixed amount of dividends annually from the company's net profits.
• Convertible Preference Shares: These are preferential shares for which shareholders may ask for cash payment or the conversion of preference shares into equity.
• Non-Convertible Preference Shares: These shares can be redeemed at the end of their tenure, but they are not convertible into equity shares.

Features of Preference Shares

Preference shares include the following features. 

• When it comes to dividend payments or the distribution of assets in the case of a liquidation, a company typically gives priority to preference shareholders.
• These shares may be converted into equity shares with the approval of the Board of Directors or after a specific date.
• The company can buy back its preferred stocks on certain predetermined dates. 

Similarities Between Equity Shares and Preference Shares

Apart from the difference between preference shares and equity shares, these two types of shares possess some similarities too. This includes the following.  

• Ownership of Assets of the Firm: Equity and Preference shares confer ownership rights to shareholders, granting them a partial stake in the company. Shareholders can claim a portion of the firm's assets and potential profits.
• Potential Income from Dividend: The shares of both types can provide returns in the form of dividends, which however may differ.
• Potential for Return on Value: The value of an equity share and preference share increases with time, offering the possibility of capital gain. This increase is based on the performance of the company and market trends.
• Tradable on Stock Exchanges: Generally, both types of shares are subject to trading on the stock exchanges. This allows investors to easily enter and exit a position in the share market.
• Subject to Market Fluctuations: Both equity and preference shares are subject to market risks due to the variations in their values with changes in market situations.

Conclusion
The Equity and Preference share differences represent different investment options with unique benefits and risks. Equity shares grant ownership and voting rights, while preference shares offer predetermined dividends. Investment in the equity share and preference share depends on your risk appetite, time frame, and financial goals. You can access both types of shares with a stock market app. They are essential elements of the capital structure and investor’s portfolio. Understanding their characteristics helps align the investments to your objectives.