The world of stocks can be a bit confusing at times. You have stocks, shares, debentures, and many more terms. The number of people investing in stocks and shares is increasing with every passing day. This blog will help you understand what shares are and how they work. We will take a look at two major types of shares – equity shares and preference shares.
Now, what are shares? To answer this simply, we say
Shares are a type of security issued by a company to investors by way of financing a company’s operations. Although a share is a security, it differs from bonds or a debenture as a share represents beneficial ownership in a company, whereas bonds and debentures represent a debt owed by a company.
Equity shares and preference shares are commonly used terms to refer to a type of security that investors buy and sell on a stock exchange to raise capital for a company.
It’s always essential to know what you are investing in. I’ve seen many people make investment mistakes because they didn’t know the difference. For example, an investor may think they are investing in the same stock as the one their broker told them about, but they are actually investing in shares that are different. This blog will discuss shares, the differences between Equity Shares and Preference Shares, but first, we’ll look at what equity shares and preference shares are and the history behind them.
What are Equity Shares?
Equity shares are the type of shares issued by companies to their investors to raise capital for the company. The funds raised are used for the expansion and development of the company. It is for the same reason that equity shares can be called the “pillars of the company”. These are generally also called ‘ordinary shares’.
This type of share comes under long-term investing and thus is a permanent source of capital. Equity shares are traded through the stock exchange in the market and thus their value isn’t constant.
Equity shareholders have no preferential rights in terms of getting a fixed rate of dividend or receiving the principal amount at the time of liquidation of the company. They do not have any fixed rate of dividend and thus are always at the edge of the knife. The rate of dividend or profit depends on the performance of the company, so it keeps on fluctuating over the period. This is the point where it creates the major difference between equity shares and preference shares.
Notably, the company is not obliged to pay dividends to equity shareholders if the company is running on loss. This means that at the time of liquidation, the liability arising out of equity shares is required to be paid first including all debts, loans, and other preference shares. This shows that equity shareholders are always risk-taking investors.
Equity shares are non-redeemable which means they cannot be redeemed during the lifetime of the company. This makes them a long-term source of finance for the company. But these shares are transferable and can be sold to any other shareholders. One can also convert its equity shares to preference shares of the company as they are convertible in nature. This gives an advantage of equity shares over preference shares.
Now before we move on to comparing all the differences between equity shares and preference shares side by side, let us first understand the basics of preference shares.
What are Preference shares?
Preference shares are the types of shares issued by the companies that are entitled to be paid out to the shareholders before the repayment of equity shareholders. These shares have preferential rights over the company like getting a fixed rate of dividend and receiving the principal amount at the time of liquidation of the company. The priority of preference shares lies between debts and equity shares, which means shareholders of preference shares are paid after clearing the debts and loans of the company but before the equity shares. This is one of the pros of preference shares, that they don’t have to take any risk on their investment and their fixed dividend is paid back to them anyway even when the company is incurring losses.
Just like the two sides of the coin, everything in this world has both its pros and cons. The same thing applies here, and there are several cons of preference shares over equity shares. The main difference between these two is the type of voting rights they offer to the investors. Equity shares provide voting rights to investors in terms of common decisions like dividends, issuance of additional shares, mergers, and acquisitions, etc.
When preference shareholders enjoy their fixed dividend rate without taking any risk, they lack the voting rights of the company. They are treated as just mere shareholders of the company who are paid out according to the number of shares they own. But in the case of equity shareholders, the unit of equity shares owned by an individual determines the proportion of ownership of that individual in the said company.
The shareholders of preference shares have no claim over the bonus shares of the company. Also, they don’t have any power or right to control and manage a company’s decisions and thus don’t possess ownership of the company.
Equity shares and preference shares are both shares of common stocks but before investing your bucks in them, you must consider these points and then choose the best type of share that fits your budget and interest as well.
12 major differences between equity and preference shares according to the following parameters-
|S.N||Basis of differentiation||Equity shares||Preference shares|
|1.||Rate of dividend||Do not receive a fixed rate of dividend.||Enjoys fixed rate of dividend.|
|2.||Repayment of capital||Repaid after both debts and preference shares.||Repaid after debts but before equity shares|
|3.||Voting rights||Have the privilege of full voting rights in the company’s decisions and plans.||Do not possess any voting rights in making company decisions and plans.|
|4.||Face value||Generally are low face values as compared to preference shares.||Generally are of high face value as compared to preference shares.|
|5.||Ownership||Represents the ownership of the company and can claim assets of the company.||Does not represent ownership and has no claim over the company.|
|6.||Types||They are ordinary shares and thus have no types.||There are several types of preference shares like cumulative, non-cumulative, convertible, non-convertible, participatory, non-participatory, etc|
|7.||Convertibility||They are convertible shares and can be converted to preference shares.||They are non-convertible shares and cannot be converted into equity shares.|
|8.||Capitalization||Its chances are high of over capitalisation.||Relatively low chance of over capitalisation.|
|9.||Types of Investors||Suitable for risk-taking investors.||Best for risk-averse investors.|
|10.||Dividend payout||Companies are not obliged to pay off equity dividends and it totally depends on the company’s profit or loss.||The company must pay off dividends of different shareholders even when the company is at loss.|
|11.||Liquidation||They have residual rights over the assets of the company after all the repayment of debtors and preference shareholders.||They have first right before the repayment of equity shareholders.|
|12.||Participation rights||They have all the primary rights and are responsible for the management of the company.||They are not responsible for the company’s management.|
For person X who is more financially stable, equity shares can be a better option as he doesn’t have to think much about the risk of losing when the company is incurring a loss. Besides, he can enjoy extra bonus shares when the company is doing well and making more profit in the market.
Similarly, for a person Y who is not much financially stable but wants to invest in shares to gain profit, preference shares can be a better option as he cannot take any risk on his investment and wants to be on the safer side of getting fixed d rate of dividends.
Now, to be honest with you, both shares are profitable and successful in their way but it is you who has to decide which share is best according to your financial statement and interest. Both the shares have their own merits and demerits at the same time. So before spending your hundreds and thousands of bucks on any shares make sure you know the difference between equity shares and preference shares.