Difference Between Equity Shares and Preference Shares
Shares are units of ownership in a company. When you buy shares of a company, you become one of its owners. There are two main types of shares: Equity Shares and Preference Shares. While both represent ownership in a company, they differ in terms of rights, benefits, and responsibilities.
In this article, we’ll explain the meaning of equity and preference shares, their key differences, and examples to make it simple to understand.
What Are Equity Shares?
Equity shares, also called ordinary shares, are the most common type of shares issued by a company. If you own equity shares, you are considered an owner of the company and have voting rights to participate in important company decisions, like electing directors or approving major plans.
Key Features of Equity Shares:
- Voting Rights: Equity shareholders can vote at the company’s meetings and have a say in decision-making.
- Variable Dividends: The dividend (profit paid to shareholders) for equity shares is not fixed. It depends on the company’s performance and the profits made in a given year.
- High Risk, High Return: Equity shareholders bear more risk because their dividend and capital depend on the company’s profits. However, they have the potential to earn higher returns if the company does well.
- Ownership: Equity shareholders are the real owners of the company and have the last claim on the company’s assets during liquidation (after debts and preference shares are paid).
What Are Preference Shares?
Preference shares, as the name suggests, give shareholders preference over equity shareholders when it comes to receiving dividends and capital repayment. They are considered a hybrid between equity and debt because they provide fixed returns but do not typically come with voting rights.
Key Features of Preference Shares:
- Fixed Dividends: Preference shareholders receive a fixed dividend, regardless of the company’s profits.
- Priority Over Equity Shares: During liquidation or bankruptcy, preference shareholders are paid before equity shareholders.
- Limited or No Voting Rights: In most cases, preference shareholders do not have voting rights in the company.
- Lower Risk, Lower Return: Since the dividend is fixed and they get paid first, preference shares are less risky than equity shares, but the returns are usually lower.
Key Differences Between Equity Shares and Preference Shares
Aspect | Equity Shares | Preference Shares |
---|---|---|
Ownership | Represents ownership in the company. | Provides limited ownership but no voting rights. |
Voting Rights | Shareholders have voting rights. | Shareholders usually do not have voting rights. |
Dividend Payment | Variable dividend based on company profits. | Fixed dividend, regardless of profits. |
Risk Level | Higher risk due to profit dependency and last claim. | Lower risk because of priority in payment. |
Returns | Potential for high returns when the company does well. | Returns are fixed and generally lower. |
Repayment Priority | Paid after preference shareholders during liquidation. | Paid before equity shareholders during liquidation. |
Example to Illustrate
Let’s assume a company has two types of shareholders: equity shareholders and preference shareholders.
- The company earns a profit of ₹10,00,000 in a year. It decides to distribute ₹2,00,000 as dividends.
- The preference shareholders are entitled to a fixed 8% dividend on their investment of ₹5,00,000. This means they will receive ₹40,000 (₹5,00,000 × 8%).
- The remaining ₹1,60,000 is distributed among equity shareholders. If there are 10,000 equity shares, each equity share will get ₹16 (₹1,60,000 ÷ 10,000).
If the company makes no profit, preference shareholders may still receive their fixed dividend (if the terms allow), but equity shareholders will get nothing because their dividend depends on profits.
Which is Better: Equity or Preference Shares?
The choice between equity shares and preference shares depends on your financial goals and risk tolerance:
- Equity Shares: Suitable for investors looking for high returns and who are willing to take higher risks. Ideal if you want voting rights and are confident in the company’s growth potential.
- Preference Shares: Suitable for conservative investors who prefer fixed returns and lower risk. Good for those who don’t need voting rights but want priority in payments.
Conclusion
Both equity shares and preference shares play important roles in a company’s financial structure. Equity shares give you ownership and higher potential returns but come with higher risks. Preference shares offer fixed returns and priority in payments but usually don’t grant voting rights.
Understanding these differences can help you make informed investment decisions based on your financial goals, risk appetite, and the company’s performance.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investing involves risk. Consult with a qualified professional before making any investment decisions.