Equity Shares and Preference Shares

We have often heard about the term ‘shares’ in the financial sector. The definition of the term share lies in the word itself. But we may not know about the term in detail. A share, in the finance market, means a unit used as limited partnerships, mutual funds, and real estate investment trusts. A person who holds the share(s) in a particular company is known as the shareholder of the organization. In a further technical term, a share is a unit of capital that cannot be divided and it expresses the ownership relationship between the shareholder and the corporation. 

Everything about shares is not an easy task to understand. For this purpose, we have to understand the basics of the equity shares and preference shares only, in detail. 

Equity Shares

The other name of ‘equity share’ is ‘ordinary share’. It is a subset under the fractional ownership or part ownership in which the shareholder tackles the maximum business risk as a fractional owner. Generally, the members of the company with voting rights are the holders of Equity Shares. Long-term capital is raised with the aid of Equity shares. Equity shareholders are called ‘residual owners’. They are paid the residual amount after the settlement of claims on the company’s income and assets. These shareholders can take part in the management of the company through their voting rights.

Advantages of Equity Share

1. Equity capital is the building block of a company. It is the last thing added in the list of claims and it produces a cushion for creditors.

2. Equity capital generates creditworthiness to the company and boosts up the confidence of various loan producers.

3. Equity shares are preferred by investors who are willing to take larger risks.

4. It is not compulsory to pay the dividend to the equity shareholders. So, the company will not face any burden for this.

5. The funds are raised by equity issues without generating any charge on the assets of the company.

6. The management of the company may be controlled by the equity shareholders by their voting rights.

Disadvantages of Equity Shares

1. Risk-averse investors with the preference of fixed income will not like equity shares.

2. The cost of raising funds from other sources is lower than the cost of equity shares.

3. The voting rights and earnings of existing equity shareholders are dismissed by the issue of the additional equity shares.

4. Equity share is a time-consuming process as it involves various formalities and administrative delays.

Preference Shares

Preference Shares are the shares which guarantee the holder a fixed and steady dividend, whose payment takes priority over the equity share dividends. Capital raised by the issue of preference shares is termed as preference share capital.

The basic difference between preference shareholder and equity shareholder is that preference shareholders are in a better position over the equity shareholders. Preference shareholders receive a fixed and steady dividend from the revenue of the company before an equity shareholder gets any dividend. 

Types of Preference Share

There are three types of preference shareholders namely Cumulative and Non-Cumulative, Participating and Non-participating and Convertible and Non-Convertible.

a) Cumulative and Non-Cumulative

Cumulative preference shares are known as the preference shares that have the power to collect dividends which are not paid in the future years, in case the same is not paid during a year. If the dividend is not accumulated over the unpaid dividends in a particular year it is called Non-cumulative shares.

b) Participating and Non-Participating

Preference shares which have the power to take part in the extra surplus of company shares which, after dividend, is paid at a fixed rate on equity shares are called participating preference shares. In the case of non-participating preference shares, the above power is not exercised. 

c) Convertible and Non-Convertible

If the preference share is converted into equity shares for a certain period of time, it is called convertible preference share. The rest is called non-convertible preference share.

Advantages of Preference Share

1. It does not influence the control of equity shareholders over the management.

2. There may be a hike in dividend for the equity shareholders in the good time.

3. The income of the shareholders is steady and fixed.

4. They have a preferential power of repayment over the equity shareholders.

5. Any sort of charge against the assets of a company is not created by the preference capital.

Disadvantages of Preference Share

1. The amount dividend is higher than the rate of interest on debentures.  

2. The dividend on these shares is regulated by the revenue of the company.

3. Risk lover persons will not prefer this kind of share.

4. Claims of equity shareholders diluted by the preference capital.

5. It is not possible to deduct the dividend paid from the profits as an expense.

So, in a nutshell, shares of certain companies are based on two types of shares namely equity shares and preference shares. Both the shares are equally important in respect of shareholders of companies and both of them have certain merits and demerits.