Knowledge is critical, especially if you are a new investor. You come across a variety of jargons and wonder what all these means. Equity shares vs preference shares is one such topic that you’ll encounter on your very first effort to enter the market. Don’t worry! We will explain each to you in the simplest way possible.
When we say the equity market, we use it as a blanket term to describe all the types of asset classes that trade in the stock market. But the reality is far from that. Companies issue different kinds of stocks to raise funds from the market, and it’ll help to know the types to select the right ones for your portfolio.
Equity shares and preference shares are very similar, and yet they are different. The difference is mainly in the ways they entitle shareholders to receive dividends.
Both equity shares and preference shares have different features and suitable for investors with different requirements. So, let’s try to understand the differences in detail.
What Is The Difference Between Equity Share And Preference Share?
Both represent ownership capital and entitles you to have a claim on the company’s profit in the form of a dividend, announced by the corporate. When profit share is announced, preference shareholders have the first claim. They receive their bonus at a fixed rate but don’t enjoy voting rights in the majority of companies like equity shareholders do.
When we talk about investing in stocks, we usually refer to equity shares, which are also called general shares. With this, a company offers you partial ownership in the company and therefore, it involves high risk. Profit on equity shares depends on the company’s performance. And so, your dividend percentage will also fluctuate, which means you might not receive any dividend at times. But with preference shares, the company is bound to pay the dividend.
Secondly, risks of an equity shareholder are the same as what the company experience. As compared to them, risk exposure of preference shareholders is nominal. So, they also have a preferential claim on receiving their capital back before the company settles its general shareholders.
It may sound like preferential shareholders enjoy all the cream while equity shareholders receive only a little return on their investment. But it is not entirely true. General shareholders enjoy ownership in the company; including voting rights in major company decisions, like mergers and acquisitions. Further, they play a crucial role in forming a company’s equity capital, which reflects its creditworthiness. Apart from these, general shareholders also enjoy some added privileges. Let’s take a look at the salient differences between equity shares and preference shares in the table below.
Equity Shares vs Preference Shares
|Areas compared||Preference shares||Equity shares|
|Dividend payment||A fixed dividend is paid||Depends on the company’s performance. A company can even decide not to pay any dividend to its general shareholders for a year|
|Arrears||Gets accumulated||Not accumulated|
|Preferential rights||Claims of preferential investors are settled before equity shareholders||Treated after other debts are settled|
|Bankruptcy||Have the preferential right to receive capital before equity shareholders||Paid after preference shares are fully paid|
|Risk exposure||Safer than equity shares||Subject to market volatility and company’s performance|
|Rights||Have no rights to vote||Enjoy rights to vote in major company decisions|
|Participation in management||Not allowed||Have say in management decisions|
|Traded in Exchange||Not traded in exchange||Traded in exchange|
|Liquidity||Not liquid. But the shareholder can sell it back to the company after a fixed period||Highly liquid|
Commonly, preference shares are issued to institutional investors such as banks, NBFCs and the like, and not to retail investors.
Preference shares are issued when a company is required to raise capital from the market but doesn’t want a loan. Capital raised through preference shares helps build its capital foundation and gets reflected as an asset in the balance sheet. Loan, on the other hand, reflects as a liability.
As a general investor, you can only enrol for the equity shares of a company. But you may still benefit from knowing the differences between equity shares and preference shares. The more you learn about the equity market, the more confident you become with your investment choices.