Difference Between Equity Shares and Preference Shares

The issue of shares is a crucial decision to a company with the main objective of raising funds for expansion. The share capital is the equity component of the company received through selling ownership of shares to the public investors, and it can be issued as equity shares or preference shares. The key difference between equity shares and preference shares is that equity shares are owned by the principal owners of the company while preference shares carry preferential rights with regard to dividend and capital repayment.

CONTENTS
1. Overview and Key Difference
2. What is Equity Shares?
3. What is Preference Shares?
4. Side by Side Comparison – Equity Shares vs Preference Shares

What are Equity Shares?

Equity shares, also known as ‘common shares’ or ‘ordinary shares’, represent the ownership of the company. Equity shareholders are entitled to voting rights of the company. Maintaining voting rights exclusive to equity shareholders allow them to avoid other parties involved in major decisions such as mergers and acquisitions and election of board members. Each share carries one vote.  However, in some situations, certain companies may issue a portion of non-voting equity shares as well.

Equity shareholders also receive dividends at a fluctuating rate since the dividends will be paid after preference shareholders. In a situation of company liquidation, all the outstanding creditors and preference shareholders will be paid off before equity shareholders. Thus, equity shares carry higher risk in comparison with preference shares.

What are Preference Shares?

Preference Shares are often classified as hybrid securities since dividends can be paid at a fixed or a floating rate. These shares do not have the authority of voting in company matters, however, receives dividends at a guaranteed rate. Furthermore, preference shareholders are paid off prior to equity shareholders in a situation of liquidation; thus, the risk carried by these are relatively low. Preference shareholders are often considered as lenders of capital to the company than actual owners.

The decision whether to invest in equity shares or preference shares depends on the risks that an investor is willing to take and the requirement of returns. For an ordinary shareholder, the main objective of holding equity shares is to receive a capital gain (an increase in share price). Preference shares are primarily held to receive a fixed income in the form of dividends.

Types of Preference Shares

Cumulative preference shares

Preference shareholders often receive cash dividends. If a dividend is not paid in one financial year due to lower profits, then the dividend will be accumulated and is payable to the shareholders at a later date.

Noncumulative preference shares

This type of preference shares does not carry the opportunity to claim dividend payments at a later date.

Participatory preference shares

These type of preference shares carry an additional dividend if the company meets pre-determined performance goals in addition to the normal dividend payment.

Convertible preference shares

These preference shares come with the option to be converted to a number of ordinary shares at a pre-agreed date.

What is the difference between Equity Shares and Preference Shares?

Reference:

“Company Law Club : A Company Law Solutions Company.” Company Law Club: Classes of shares. N.p., n.d. Web. 03 Feb. 2017.

Horton, Melissa. “What is the difference between preferred stock and common stock?” Investopedia. N.p., 04 Nov. 2004. Web. 03 Feb. 2017.

“Voting Right.” Investopedia. N.p., 23 Nov. 2003. Web. 03 Feb. 2017.

“Comparing Common Stock, Preferred Stock, and Debt – Boundless Open Textbook.” Boundless. N.p., n.d. Web. 03 Feb. 2017.

 Image Courtesy: 

“100 shares of the Chicago Great Western Railway” by H. Michael Miley (CC BY-SA 2.0) via Flickr