Difference Between Equity Shares and Preference Shares (With Table)
Equity shares are a fundamental concept in Commerce, widely discussed in subjects like Accounting, Business Studies, and Economics. Equity shares, commonly known as ordinary shares, represent the main form of long-term capital raised by companies from the public. When individuals buy equity shares, they become partial owners of the company and may receive a portion of the profits in the form of dividends. Equity shareholders are also entitled to voting rights, influencing major corporate decisions.
Equity Shares Meaning and Explanation
Equity shares are issued to the public and are non-redeemable in nature, which means the invested capital is not returned during the company’s lifetime unless it is liquidated. These shares form a crucial base for the company’s financial stability. The value of an equity share can be expressed as par value, face value, or book value. People holding equity shares enjoy rights such as voting, profit sharing, and claims on company assets in case of winding up.
Ordinary shares allow investors to gain exposure to management and strategic decisions. Shareholders holding a large number of shares can exercise significant influence by using their voting rights effectively.
Types of Equity Shares
Equity shares come in various types. Understanding their features helps in analyzing their utility and relevance in the capital market.
| Type | Description |
|---|---|
| Ordinary Shares | Issued for raising long-term funds, provide voting rights and ownership benefits to investors. |
| Preference Equity Shares | Issued to ensure payment of cumulative dividends before ordinary shareholders. They usually lack voting rights. |
| Bonus Shares | Issued from retained earnings as additional shares to existing shareholders, representing profit distribution without increasing market capitalization. |
| Rights Shares | Offered to premium investors at a discount within a specified time to raise additional funds for the company. |
Key Features of Equity Shares
- Equity shares are a permanent source of finance for the company.
- Shareholders have voting rights and can influence company management.
- Dividends are not fixed; they depend on company profits and performance.
- Equity shares provide partial ownership of company assets and profits.
- They can be transferred or traded in the stock market, adding liquidity.
Why Should You Invest in Equity Shares?
- Potential for high returns through both capital appreciation and dividends.
- Hedge against inflation.
- Portfolio diversification.
Risks Associated with Investing in Equity Shares
- High volatility—share prices fluctuate due to market conditions, economic changes, and company performance.
- Dividends are paid only after fulfilling company’s other obligations. During downturns, dividends may decline or not be paid.
- Equity shareholders bear the highest risk, as their claims are settled last in case the company winds up.
Over time, patient investors may benefit as market cycles recover. However, risk-averse investors might consider other options.
Alternative Investment Option: Debt Securities
Debt instruments are less risky compared to equity shares. They promise lower but steadier returns and may appeal to conservative investors. However, debt securities do not provide the wealth creation potential of equity shares.
Practical Example and Problem-Solving Approach
Suppose a company issues 5000 equity shares with a face value of ₹10 each, and announces a dividend of 8%. The total dividend distributed is calculated as:
Total Dividend = Number of Shares × Face Value × Dividend Percentage
= 5000 × ₹10 × 8% = 5000 × ₹10 × 0.08 = ₹4,000
This approach can be applied to different share-related problems, including calculating dividend yield or total payout.
Comparison: Equity Shares vs. Preference Equity Shares
| Basis | Equity Shares | Preference Equity Shares |
|---|---|---|
| Dividend | Not fixed; paid after preference shares | Fixed; paid before equity shareholders |
| Voting Rights | Yes | No |
| Ownership & Control | Greater influence through voting | No control over management |
| Risk Level | Highest | Lower |
Key Principles and Applications
Equity shares serve as a foundation for capital formation. They allow companies to raise funds for growth, while offering investors a chance to participate in the profits and management of the business. Investing in equity shares is best suited for those who seek higher returns and are willing to accept higher risk.
Practice Questions
- List three main differences between equity shares and preference equity shares.
- Explain why equity shares are considered a permanent source of capital.
- Calculate the dividend for 2000 equity shares of ₹10 each at a dividend rate of 6%.
Next Steps and Vedantu Resources
- Continue learning more about shares, capital structure, and investments by accessing class notes and commerce study guides on Vedantu.
- Practice more numerical problems and concept questions for better understanding and exam preparation.
FAQs on Equity Shares Explained: Meaning, Types, Features & Examples
1. What are equity shares?
Equity shares are the main type of shares representing ownership in a company.
• Equity shareholders have voting rights and share in company profits via dividends.
• There is no fixed dividend rate; returns depend on company performance.
• They carry higher risks and potential rewards compared to other shares.
2. What is the difference between equity shares and preference shares?
Equity shares and preference shares differ in several ways:
• Equity shares offer voting rights and variable dividends, while preference shares have fixed dividends but usually no voting rights.
• At liquidation, preference shareholders are paid before equity shareholders.
• Equity shares involve higher risk and potential return; preference shares offer steady, lower-risk returns.
3. What are the main types of equity shares?
Types of equity shares include:
• Ordinary (equity) shares: Standard shares with voting rights.
• Bonus shares: Issued free to existing shareholders from company reserves.
• Right shares: Offered to current shareholders at a discount to raise additional capital.
• Sweat equity shares: Issued to employees or directors for their services or contribution.
4. What are the key features of equity shares?
Key features of equity shares:
• Ownership and control of the company
• Voting rights at company meetings
• Dividend based on profits and board policy
• Free transferability in stock markets
• Residual claim after other obligations on liquidation
5. Are equity shares a good investment?
Equity shares can be a good investment for those willing to accept higher risk for potentially higher returns. They offer capital appreciation and dividends, but value may fluctuate with market performance.
6. How can an investor buy equity shares in India?
To buy equity shares in India:
1. Open a Demat and trading account with a SEBI-registered broker.
2. Complete KYC using PAN and Aadhaar.
3. Place a buy order on stock exchanges like BSE or NSE.
4. Shares will be credited to your Demat account after settlement.
7. Do equity shareholders get fixed dividends?
No, equity shareholders receive variable dividends based on company profits and decisions made by the Board of Directors. Dividend payments are not guaranteed every year.
8. What are the advantages of equity shares for companies?
Advantages for companies issuing equity shares:
• Permanent source of capital, as shares are non-redeemable
• No fixed dividend liability
• Improves company’s creditworthiness
• Helps diversify ownership and management
9. What are the risks associated with investing in equity shares?
Risks of investing in equity shares include:
• Market price volatility affecting share value
• Possibility of low or no dividend during unprofitable years
• Highest risk among all types of share capital
• Subject to economic cycles and company performance
10. Can a private company issue equity shares?
Yes, a private company can issue equity shares, but to a limited number of investors as specified by the Companies Act, 2013. Private companies cannot invite the public to subscribe to their shares.
11. How is dividend on equity shares calculated?
To calculate dividend on equity shares:
• Multiply the total number of shares by the face value and the declared dividend rate.
Example: If a company has 5,000 equity shares of ₹10 each, and the dividend declared is 10%, Total Dividend = 5,000 × ₹10 × 10% = ₹5,000.
12. What rights do equity shareholders have?
Equity shareholders have the following rights:
• Voting rights at company general meetings
• Right to receive dividends
• Right to transfer shares
• Right to share in residual assets on company liquidation
