What is the difference between equity shares and preference shares?
Introduction
Equity shares and preference shares are two common types of shares issued by companies to raise capital. They differ in terms of ownership rights, dividend payments, and risk characteristics. Here's a comparison between equity shares and preference shares:
Ownership Rights:
Equity Shares:
Equity shares represent ownership in the company and entitle the shareholders to voting rights at company meetings. Equity shareholders have the right to participate in the management of the company by voting on important matters such as the appointment of directors, mergers, acquisitions, and major policy decisions.
Preference Shares:
Preference shares do not typically carry voting rights, or if they do, they are often limited. Preference shareholders generally do not have a say in the management of the company. However, they have preferential rights over equity shareholders in terms of dividend payments and repayment of capital in the event of liquidation.
Dividend Payments:
Equity Shares:
Dividends on equity shares are not fixed and are distributed at the discretion of the company's management. The amount of dividend paid to equity shareholders may vary from year to year depending on the company's profitability and other factors.
Preference Shares:
Preference shareholders are entitled to receive dividends at a fixed rate, which is specified in the terms of the preference share issue. The dividend on preference shares must be paid out before any dividends can be distributed to equity shareholders. However, if the company does not make a profit or has insufficient profits, preference shareholders may not receive any dividend.
Repayment of Capital:
Equity Shares:
In the event of liquidation or winding up of the company, equity shareholders are entitled to receive the remaining assets of the company after all creditors, including preference shareholders, have been paid off. However, since equity shareholders bear the highest risk, they may not receive any repayment if the company's assets are insufficient to cover its liabilities.
Preference Shares:
Preference shareholders have preferential rights over equity shareholders in terms of repayment of capital in the event of liquidation. They are entitled to receive their capital back before equity shareholders but after creditors. However, the repayment of capital to preference shareholders is subject to the availability of assets in the company.
Risk and Return:
Equity Shares:
Equity shares are considered riskier than preference shares because they are more susceptible to fluctuations in the company's performance and market conditions. However, they also offer the potential for higher returns through capital appreciation and dividends.
Preference Shares:
Preference shares are less risky than equity shares because they offer fixed dividends and preferential treatment in terms of repayment of capital. However, they typically offer lower returns compared to equity shares.
Summary
Equity shares represent ownership in the company with voting rights and variable dividends, while preference shares provide fixed dividends and preferential treatment in terms of dividend payments and capital repayment but generally do not carry voting rights. Investors choose between equity shares and preference shares based on their risk tolerance, income needs, and investment objectives.
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