Distinction between Preference shares and equity shares

10th October 2022 0 By indiafreenotes

Preference Shares

Preference shares or preferred stock represent ownership in a company. Preference shareholders enjoy the preference over common shareholders on the assets and earnings. Also, in case of bankruptcy, preferred shareholders enjoy the priority to receive the company’s assets before common shareholders.

A company issues preference shares to raise capital. This becomes part of the preference share capital. Preference shareholders receive dividends before the equity shareholders. A specific type of preference share is eligible to receive arrears of dividends. Furthermore, you can easily convert these shares to equity shares.

The following are the types of preference shares:

  • Participating Preference Shares
  • Non-Participating Preference Shares
  • Convertible Preference Shares
  • Non-Convertible Preference Shares
  • Cumulative Preference Shares
  • Non-Cumulative Preference Shares

Equity Shares

Equity shares are the ordinary shares of the company. The holder of the equity shares are the real owners of the company, i.e. the amount of shares held by them is the portion of their ownership in the company.

Equity shareholders have some privileges like they get voting rights at the general meeting, they can appoint or remove the directors and auditors of the company. Apart from that, they have the right to get the profits of the company, i.e. the more the profit, the more is their dividend and vice versa. Therefore, the amount of dividends is not fixed. This does not mean that they will get the whole profit, but the residual profit, which remains after paying all expenses and liabilities on the company.

Meaning Equity shares are the ordinary shares of the company representing the part ownership of the shareholder in the company. Preference shares are the shares that carry preferential rights on the matters of payment of dividend and repayment of capital.
Payment of dividend The dividend is paid after the payment of all liabilities. Priority in payment of dividend over equity shareholders.
Repayment of capital In the event of winding up of the company, equity shares are repaid at the end. In the event of winding up of the company, preference shares are repaid before equity shares.
Rate of dividend Fluctuating Fixed
Redemption No Yes
Voting rights Equity shares carry voting rights. Normally, preference shares do not carry voting rights. However, in special circumstances, they get voting rights.
Convertibility Equity shares can never be converted. Preference shares can be converted into equity shares.
Arrears of Dividend Equity shareholders have no rights to get arrears of the dividend for the previous years. Preference shareholders generally get the arrears of dividend along with the present year’s dividend, if not paid in the last previous year, except in the case of non-cumulative preference shares.

  Equity Shares Preference Shares
Definition Equity shares represent the ownership of a company. Preference shareholders have a preferential right or claim over the company’s profits and assets.
Return Capital appreciation Regular dividend income
Dividend Pay-out Equity shareholders receive dividends only after the preference shareholders receive their dividends. Preference shareholders have the priority to receive dividends.
Dividend Rate Varies based on the earnings. The rate is fixed.
Bonus Shares Equity shareholders are eligible to receive bonus shares against their existing holdings. Preference shareholders do not receive any bonus shares against their holdings.
Capital Repayment Equity shareholders are paid last. Preference shareholders are paid before the equity shareholder when the company is winding up.
Voting Rights Equity shareholders enjoy voting rights. Preference shareholders do not enjoy voting rights.
Participation in Management Decisions Equity shareholders have voting rights, and as a result, they participate in the management decisions. Preference shareholders do not participate in management operations.
Redemption Equity shares cannot be redeemed. Preference shares can be redeemed.
Convertibility Equity shares cannot be converted. Preference shares can be converted to equity shares.
Arrears of Dividend Equity shareholders do not receive arrears of dividends. Certain types of preference shareholders are eligible for arrears of dividends.
Capitalization High chance Low chance
Types Ordinary shares, Bonus shares, Rights shares, Sweat equity, and Employee stock options. Convertible, Non-Convertible, Redeemable,  Irredeemable, Participating, Non-Participating, Cumulative, Non-Cumulative, Preference Share with a Callable Option, and Adjustable Preference Shares
Financing Source of long term financing. Source of medium to long term financing.
Mandate Companies have to issue equity share capital. All companies don’t have to issue preference share capital.
Investment Lower investment option. High investment option.
Suitability High risk-takers Low risk or risk-averse investors
Company’s Obligation The company has no obligation to pay dividends to equity shareholders. The company is obligated to pay dividends to preferred shareholders.
Liquidity Highly liquid, traded on the stock market. Not liquid, but the company can buy back the shares.
Bankruptcy Equity shareholders are paid only after fully paying the preference shareholders. Preference shareholders have a preferential claim over the assets. Therefore, they are paid before equity shareholders.
Liquidation Equity shareholders are paid only after making payments to creditors and preference shareholders. Preference shareholders are paid after paying the creditors and before the equity shareholders.