A Comparative Study Between Equity Shares And Preference Shares

Key Takeaways

• Equity shares, which are often referred to as ordinary shares, are issued to the general public at a pre-declared face value. As more shares are sold, more capital flow in, making it the main source of investment for a company.
• Equity shares offer the largest return on investment at the expense of the most risk.
• Preference shares are the shares in which shareholders get dividends from the company's profits before equity shareholders at a dividend rate.
• Preference shares provide a fixed amount of money at the expense of zero or very little risk.

Equity shares

The primary way that the company raises money is through equity shares. In this type of partial or part ownership, shareholders take on the majority of the company's financial risk. Collectively, all equity shareholders are the company's owners, and they have the power to manage its affairs. The number of shares a shareholder holds determines how much of the company they own. The profits of the company are distributed to equity owners in the form of dividends, but the pay out rate is not fixed and varies according to profit, so if profit is higher, they will receive a higher dividend, and vice versa. Ordinary shares are another name for equity shares.

Merits of Equity Shares

• The cornerstone of a company's capital is equity capital. It comes in last on the list of claims and acts as a safety net for creditors.
• Equity capital establishes the company's creditworthiness and inspires confidence in potential loan providers.
• Equity shares are preferred by investors ready to assume greater risk in exchange for greater profits.
• Since the payment of a dividend to equity shareholders is not required, the company is not burdened.
• Without placing a lien on the company's assets, equity issues raise money.
• Equity shareholders' voting rights provide them with democratic control over the company's management.

Limitations of Equity Shares

• Equity shares may not be preferred by investors who desire regular income.
• When compared to alternative methods of financing, equity shares are more costly.
• The voting rights and profits of current equity shareholders are diminished by the issuance of additional equity shares.
• It takes a long time because there are several formalities and procedural delays.

Preference shares

Asthe name suggests, preference shares are the shares in which shareholders get dividends from the company's profits before equity shareholders at a dividend rate. Preference share capital is the total amount raised by issuing preference shares. Preference shareholders lack the power to manage the business affairs of the company. Preference shareholders were compensated first from company assets in cases of company insolvency.

Types of Preference Shares

• Cumulative and Non-Cumulative: In the event that a dividend is not paid during a year, cumulative preference shares are referred to as the preference shares with the ability to collect dividends that are not paid in subsequent years. Non-cumulative shares are those in which the dividend is not added to the unpaid dividends in a given year.
• Participating and Non-Participating: Participating preference shares are those that have the right to participate in the extra surplus of the company's shares that, after dividend, is paid at a fixed rate on equity shares. The foregoing power is not used in the event of non-participating preference shares.
• Convertible and Non-Convertible: It is referred to as a convertible preference share if the preference share can be converted into equity shares for a specific amount of time. The remainder are referred to as non-convertible preference shares.

Merits of Preference Shares

• Due to the fact that preference shareholders do not have voting rights, it has no effect on how equity owners govern management.
• In periods of growth, paying a fixed rate of dividend to preference shares may drive a company to declare greater rates of dividend for equity shareholders.
• Preference shares offer investors a predetermined rate of return and a comparatively stable stream of income.
• In the case of a company's liquidation or bankruptcy, preference shareholders have a preference over equity shareholders when it comes to reimbursement obligations.
• The assets of a company are not in any way charged by preference capital.

Limitations of Preference Shares

Preference share dividend rates are often greater than debenture interest rates.

There is no guarantee of a return for the investors; the Dividend on these shares is only to be paid when the company makes a profit.

Investors who are willing to take a risk and are seeking bigger returns do not choose preference shares.

Equity shareholders' entitlements to business assets are lessened by preference capital.

The dividend payment is not an expense that may be deducted from profits. Therefore, unlike in the case of loan interest, there is no tax savings.

Key Distinctions Between Preference Shares And Equity Shares

• Preference shareholders give money to the company but do not have voting rights, whereas equity shares are the primary source of funding for the company and shareholders are owners of the company.
• Preference shares are a safer investment than equity shares.
• Preference shareholders receive dividends at a fixed rate and before Equity shareholders, whereas Equity shareholders receive profits from the company in the form of dividends at a fluctuating rate.
• The holder of an equity share is not permitted to convert that shares into preference shares, but a holder of a preference share is permitted to convert that share's shares into equity shares.
• In comparison to preference shareholders, whose voting power is constrained, equity shareholders have the right to cast votes on all issues.
• Preference shareholders do not have the authority to engage in the management of the organisation, whereas equity shareholders are permitted to do so.
• Preference shareholders receive their capital refunds following the sale of company assets during a bankruptcy, followed by equity shareholders who receive their capital amount refunds.
• Equity shareholders are not required to receive dividend payments, but preference shareholders only receive dividends when the business is profitable.
• Preference shares are preferred by investors who are willing to invest in the company but do not want to take a risk with fluctuating share price because they favour preference shares to earn fixed rate of dividends. Equity shares are for investors who are willing to take a risk and interested in a higher return.
• Equity shares are sold back to a buyer (in the stock market) whereas Preference shares are sold back to the company.

Conclusion

Any company's share price is influenced by both internal and external variables. Share investments made over the long term offered good returns over extended durations.Preference shares provide a fixed amount of money at the expense of zero or very little risk, whereas equity shares offer the largest return on investment at the expense of the most risk.

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