When a person first starts investing, he/she will come across various financial terms that they struggle to understand. However, having a clear understanding of different investment options will make it easier for investors to formulate strategies to grow their wealth.
A share is a unit of ownership in a company. The shares of a company can be further categorized into equity shares and preference shares. The following sections in this blog will focus on the differences between equity and preference shares.
What are equity shares?
Equity shares are known as ordinary or common shares, and most of the shares issued by a company belong to this category. The number of equity shares an investor owns represents their ownership in a particular company. A crucial feature of equity shares is that investors can purchase or trade them in the stock market.
An important factor that people need to be aware of is that equity shareholders have voting rights, i.e., they can cast their votes concerning company-related issues. Moreover, equity shareholders enjoy the right to receive dividends.
An equity shareholder can receive a portion of his/her profits if the company earns profits and issues dividends. But the dividend amount they receive will vary on the company’s profit margin and its decision to use the profits.
An important factor to keep in mind is that investors will not receive the entire profit. They will receive a part of the residual profit, i.e., the portion remaining after meeting all remaining liabilities and expenses.
Types of equity shares?
There are various types of equity shares, each with distinct characteristics. Here are the main types:
1. Authorised share capital
This represents the maximum value of shares that a company is legally allowed to issue to shareholders. It is the upper limit defined in the company's memorandum of association.
2. Subscribed share capital
This is the portion of the authorized share capital that shareholders have agreed to purchase or subscribe to. It may be less than the total authorized share capital.
3. Issued share capital
Issued share capital is the portion of subscribed share capital that the company has issued to shareholders. Not all subscribed shares may be immediately issued.
4. Paid-up capital
Paid-up capital is the amount of money that shareholders have fully paid for their issued shares. Shareholders may pay for shares in instalments, and this reflects the amount paid to date.
5. Bonus shares
Bonus shares are additional shares issued to existing shareholders at no cost. They are typically issued as a reward to shareholders based on the company's retained earnings.
6. Right shares
Right shares give existing shareholders the opportunity to purchase additional shares at a specified price before these shares are offered to external investors.
7. Sweat equity shares
Sweat equity shares are issued to employees or directors as part of their compensation, often at a discounted price, in recognition of their contribution to the company's growth.
What are preference shares?
Preference shares as the name implies, impart preferential rights to their owners over the common shares. In simpler words, people who own preference shares are preferred over equity shareowners when it comes to dividend distribution at a fixed rate or capital payback.
Preference shareowners have ownership in the company just like equity shareholders. But they don’t have voting rights. However, they have voting rights in matters that directly affect their preference rights. For example, when there is a reduction in the capital; or the company is thinking of winding up, preference share owners can vote.
Types of preference shares
Here are the main types of preference shares:
1. Cumulative preferred shares
These shares accumulate unpaid dividends, which must be paid in the future before common shareholders receive dividends.
2. Non-cumulative preferred shares
These shares do not accumulate unpaid dividends, so if the company skips a dividend payment, it doesn't owe those dividends to the shareholders in the future.
3. Convertible preferred shares
These shares can be converted into a predetermined number of common shares, allowing shareholders to participate in the company's growth.
4. Participating preferred shares
These shares give shareholders the opportunity to receive additional dividends beyond the fixed rate, based on the company's profits.
5. Redeemable preferred shares
These shares can be redeemed by the company at a specific date or upon meeting certain conditions.
Difference between equity and preference shares
It is time to check the differences between equity shares and preference shares:
Basis of difference |
Equity shares |
Preference shares |
Definition |
Equity shares mean you own part of the company |
Preference shareholders have the first claim on the company's profits and assets |
Return |
Offer potential for capital appreciation |
Provide consistent dividend income |
Dividend payout |
Equity shareholders receive dividends only after preference shareholders have been paid theirs |
Preference shareholders are first in line to receive dividends |
Rate of dividends |
Dividends determined by company's board of directors |
Fixed dividend rate |
Bonus shares |
Eligible for bonus shares |
No provision for bonus shares |
Capital repayment |
Repaid last during liquidation |
Repaid before equity shares |
Voting rights |
Enjoy voting rights |
Do not have voting rights |
Role in management |
Can vote on company issues |
Cannot vote in general meetings |
Redemption |
Cannot be redeemed |
Can be redeemed |
Arrears of dividend |
No benefit from arrears of dividends |
Receive arrears of dividends in addition to current dividends |
Investment period |
Suitable for long-term investors |
Ideal for medium to long-term investment |
Mandate to issue |
Companies not required to issue equity shares |
Must issue equity shares to become publicly owned |
Investment denomination |
Typically offer lower denominations |
Often of higher denominations |
Type of investors |
Attracts investors with higher risk tolerance |
Attracts investors with lower risk tolerance |
Conclusion
Equity shares have voting rights and potential for higher profits, but they're riskier and fluctuate more. Preference shares provide stable fixed dividends but often no voting rights and lower returns. Both types can diversify your portfolio and grow wealth, but knowing their differences is key for smart investing based on your goals and risk tolerance.
