Difference Between Equity Share and Preference Share

Every investor aims to maximise their returns and grow wealth. However, there is no one way to do it. There are different types of shares traded in the secondary market which can help in growing your wealth. In this blog, let’s understand equity and preference shares and their basic differences.

What are Equity Shares?

Equity shares are ordinary stocks issued by a company for the purpose of raising capital to expand their business. Investors who purchase equity share units get partial ownership of the company.  The number of equity shares an investor buys is their portion of ownership in the company. As equity shares are non-redeemable, they act as a long-term source of financing for companies. 

By investing in equity shares, you can get benefits such as dividends and capital appreciation. However, dividends are not fixed and keep fluctuating. If a company earns more profit, then the shareholders receive more profit and vice versa. Apart from voting rights, equity shareholders also enjoy the right to vote when it comes to deciding on critical matters of the company. These stocks can be traded in the market through stock exchanges. 

Here is a list of different types of equity shares:

Authorised Share Capital

Authorised share capital represents the total number of shares a company is legally permitted to issue, as defined in its Memorandum of Association (MoA). It's the maximum potential for equity funding and is distinct from the shares actually issued and outstanding.

Bonus Shares

Bonus shares are additional shares issued by a company to its existing shareholders at no cost under corporate action. These shares are distributed proportionally to the number of shares each existing shareholder holds. Companies typically use accumulated earnings or reserves to issue bonus shares, which allows them to reward investors without distributing cash dividends.

Issued Share Capital

Issued share capital represents the total value of a company's shares offered and sold to investors in IPO, FPO, and other private placements. It's the amount of capital a company has raised by selling shares, and it's a key indicator of how much equity financing the company has. Also, the number of issued shares generally corresponds to the amount of subscribed share capital, though neither amount can exceed the authorised amount.

Sweat Equity Shares

Sweat equity shares are those issued by a company to its directors or top contributing employees at non-cash consideration in recognition of their contributions of time, effort, and expertise towards the company's growth. These shares serve as a reward for their hard work and are often used in startups or early-stage businesses where the monetary compensation is limited.

Subscribed Share Capital

Subscribed share capital represents the portion of a company's issued share capital that investors have agreed to purchase and pay for. It represents the amount of share capital investors have committed to, indicating the investment interest and confidence in the company.

Right Shares

Right shares are ordinary equity shares bought when the company announces the rights issue. Here, the existing investors get a chance to buy new shares for a discounted price as per the company’s fixing of the price for the rights issue.

Paid-up Capital

Paid-up capital is the amount of money a company has received from shareholders in exchange for shares, as opposed to the maximum amount it's authorised to issue. It represents the funds the company has secured through the sale of shares, which can be used to finance operations and growth.

What are Preference Shares?

Preference shares are those that offer shareholders fixed dividends. Preferred shareholders are given their dividends before equity shareholders receive theirs. However, preference shareholders do not get the right to vote or participate in decision-making events of the company. In terms of priority and repayment of capital, preference shares can be ranked between debt and equity.

Companies issue preference shares for raising capital. There is a specific type of preference stock that receives arrears of dividends. In case of bankruptcy, preferred shareholders get priority over common shareholders and receive the company's assets before them. At any point in time, you can convert your preference shares into equity shares. 

Here is a list of different types of Preference shares

Convertible Preference Shares

Convertible preference shares are a type of preferred stock that can be exchanged for common shares after a specific period or upon the occurrence of certain events. Like traditional preferred shares, they offer investors a fixed dividend payment but also provide the potential to benefit from an increase in the value of the company's common stock.

Non-Convertible Shares

Non-convertible shares, primarily non-convertible preference shares or non-convertible debentures (NCDs), are investment securities that cannot be converted into equity or common stock. These shares offer fixed returns, typically through dividends (for preference shares) or interest (for NCDs), but investors do not gain ownership or voting rights in the company.

Non-Cumulative Preference Shares

Non-cumulative preference shares are where unpaid dividends, if any, do not accumulate or carry forward to future periods. If a company declares a dividend in a given year but doesn't pay it, non-cumulative shareholders lose their right to receive it later. This differs from cumulative preference shares, where unpaid dividends accumulate and must be paid before any dividends can be paid to ordinary shareholders.

Cumulative Preference Shares

Cumulative preference shares are a type of preference share where dividends that were missed in the past must be paid to shareholders before any dividends can be paid to common shareholders. This feature provides a safety net for investors, ensuring a consistent income stream even if the company experiences financial difficulties.

Non-Redeemable Preference Shares

Non-redeemable preference shares, irredeemable or perpetual preference shares, are not redeemable during the company's operational lifespan. The issuing company cannot repurchase them at a fixed date or a specified price. They can only be redeemed in the event of the company's liquidation or winding up.

Redeemable Preference Shares

Redeemable preference shares can be repurchased by the issuing company after a predetermined date or upon a specific event, as agreed upon at the time of issuance. These shares are redeemable at a fixed price or a price determined by a formula agreed upon at the time of issuance.

Participating Preference Shares

Participating preference shares are a type of preferred stock that, in addition to receiving a fixed dividend, also participate in a share of any surplus profits after a certain threshold is met. This offers investors the potential for higher returns than regular preferred shares, which are limited to their fixed dividend rate.

Non-Participating Preference Shares

Non-participating preference shares offer holders a fixed dividend rate and do not entitle them to share in any extra profits or assets beyond that fixed amount. These shares are prioritised for dividend payments over common stock but do not benefit from increased earnings or company growth beyond the predetermined dividend.

Key Differences Between Equity Shares and Preference Shares

Let us check out the major differences between equity shares and preference shares:

Conclusion

If you analyse the differences between equity stocks and preference stocks, you will see that both of them offer benefits in different ways. Make sure to select the most suitable investment option depending on your risk capacity and financial goals.