Among the variety of options available to companies to raise capital from the market, equity and preference shares are two distinctive pillars. When you invest in the stock market, choosing the right share type is paramount. Equity and preference shares, each carrying their own set of rights, risks, and rewards, can influence your investment decisions. Whether you are a seasoned or aspiring investor, understanding the difference between equity and preference stocks is critical. In this article, we discuss their fundamental characteristics, their implications for investors, and the strategic considerations that guide companies in choosing between these options.
What Are Equity Shares?
Equity shares represent ownership in a company. Equity investors are the real owners of the company. These shares give investors the right to vote and influence corporate decisions.
Equity shareholders participate in the company’s profits and losses, and their returns depend on its performance and stock price fluctuations. Investors could enjoy the appreciating value of the equity shares as the company experiences growth and success.
However, equity shareholders are the last to receive their claims in case of liquidation, after creditors and bondholders.
Types of Equity Shares
Equity shares are of the following types:
- Common shares: Companies issue common shares to meet long-term capital requirements. Common shares give shareholders the right to vote on the company’s decisions. Investors bear higher risks and rewards, as their dividends and value depend on the company’s performance.
- Preferred shares: These shares offer a fixed dividend to the shareholders. At the time of liquidation, preferred shareholders have a higher claim on the company’s assets.
- Bonus shares: These are free shares issued to existing shareholders from the company’s retained earnings. The company’s market capitalisation doesn’t change with bonus shares.
- Rights issues: Companies issue rights shares to specific customers on a pro-rata basis. Companies might release rights shares when they need to raise extra capital. Investors can buy these shares from the company at a special rate.
- Sweat shares: Company directors and employees receive Sweat shares for contributions to the company. These shares are issued at a special discounted rate.
- Employee stock options: ESOP shares are a part of the company’s retention strategy. Directors and employees are given the option to buy the company’s shares at a predetermined price at a future date.
What Are Preference Shares?
Preference shares, or preferred stocks, are a type of equity ownership in a company that offers fixed dividends at a higher rate. Preference stocks provide owners with a specific claim on the company’s dividend throughout the company’s lifetime.
Features of preference shares
- Fixed dividends are paid regardless of the profit earned
- They have characteristics of both debt and equity
- Preference shares often don’t offer voting rights
- Shareholders have a preferential claim over the company’s assets in cases of liquidity
Types of Preference Shares
- Convertible shares: Convertible preferred shares allow investors to convert a fixed number of these shares into common shares after a specific date.
- Non-convertible shares: Shareholders can’t convert the non-convertible shares into common shares.
- Participating preference shares: These stocks allow the shareholders to receive surplus dividends if the company’s profit exceeds a specific limit.
- Non-participating preference shares: Shareholders receive dividends at a fixed rate.
- Redeemable shares: Redeemable shares come with a clause where the company offers to buy back the shares after a fixed period on a predetermined date. It provides shareholders with an exit option.
- Non-redeemable shares: These shares cannot be redeemed or bought back by the company. Investors hold onto them until they decide to sell them on the secondary market.
Difference Between Equity and Preference Shares
The following table illustrates the differences between equity and preference shares:
| Parameters | Equity Shares | Preference Shares |
| Definition | Equity shares represent partial ownership of the company | They have a preferential right or claim over the company’s profit and assets |
| Returns | Dividends (not fixed) and capital appreciation | Fixed dividends |
| Dividend Payout | Paid after preference shareholders | Paid to the shareholders at a preferred rate before equity shareholders |
| Dividend Rate | Not fixed; depends on the company’s performance | Paid at a fixed rate |
| Liquidity | Highly liquid | Less liquid |
| Redemption | Equity shares can’t be redeemed | Can be redeemed |
| Financing | Used for long-term financing needs | Short to medium-term financing |
| Convertibility | Can’t be converted | Comes in convertible and non-convertible options |
| Arrears on dividend | No arrears on dividends | Certain types of preference shares are eligible for arrears on dividends |
| Company obligation | Company has no obligation to pay dividends to equity shareholders | Company must pay dividends regardless of its profit status |
| Investor Type | Usually high-risk investors invest here | Mostly risk-averse investors |
| Bonus Shares | Equity shareholders are eligible to be offered bonus shares | Preference shareholders are not eligible for bonus share issues |
| Capital Repayment upon liquidation | When the company is being liquidated, equity shareholders receive payments only after payment to creditors and preference shareholders | They receive their payment right after creditors |
| Participation in management decisions | Equity shareholders have voting rights that affect management decisions | Preference shareholders do not have voting rights |
| Chance of capitalisation | High | Low |
| Types | Ordinary shares, Rights shares, Bonus shares, Sweat equity, and ESOPs | Convertible, Non-Convertible, Cumulative, Non-Cumulative, Participating, Non-Participating, Redeemable, Irredeemable, Preference Share with a Callable Option, and Adjustable Preference Shares |
| Mandate | Companies must issue equity shares under share capital | All companies do not have to issue preference shares |
| Investment | Lower investment option | Higher investment option |
Final words
Equity and preference shares benefit shareholders and companies in different ways. Depending on one’s risk tolerance level and financial goals, investors can select between equity and preferred stocks. If you are interested in investing in the stock market, open a Demat account today.
FAQs
Is equity investment a good option?
Equity investments have the potential to generate higher returns in the long run. As long as you have a well-researched investment plan, you can increase your return on investment by investing in equity shares.
Who should invest in equity?
Equity investing is suitable for investors with long-term capital appreciation goals and a higher risk appetite.
Who invests in preference shares?
These shares are suitable for investors with a moderate risk appetite who have been in the market for a long time.
How do returns differ for equity and preference shareholders?
The return on equity shares depends on the company’s performance. However, shareholders received dividends at a fixed rate regardless of the company’s profit.
How do equity and preference shares differ in terms of risks?
Equity shares have higher risk due to high price volatility. Also, equity shareholders are the last to have claims on the company’s assets during liquidation. Preference shares bear lower risk with fixed dividends and preferential claims on assets.
