Difference Between Equity Shares and Preference?

According to Section 43 of the Companies Act (2013), a company can have two types of share capital- equity and preference.If you know anything about the stock market, you might know that companies list their stocks on exchanges for raising capital. The shares that you generally buy/sell on exchanges are equity shares. But apart from equity shares, companies can also raise capital through preference shares.So, what are these preference shares? Can retail investors purchase preference shares? Check out answers to these questions below-

When you invest in equity shares, you are entitled to receive dividends against your holdings every time the company has surplus profits and announces dividend distribution. However, with equity shares, the dividends depend on the company’s performance. But this is not the case with preference stocks.In simple words, preference stocks come with preferential rights for the investors. Just like equity shareholders, preference stockholders are also partial owners of the company they invest in. But unlike equity shareholders, they do not have any voting rights.However, while the dividends can vary as per the company's performance for equity shareholders, preference shareholders receive fixed dividends. In other words, they are ‘preferred’ over equity shareholders for matters such as dividend distribution and capital repayment in case if the company is liquidated.

To better understand preference shares and how they differ from equity shares, it’d be helpful if you also understood the different types of preference shares. There are basically nine different types of preference shares, each with a different meaning. Here is a brief overview of all nine-

• Convertible- The convertible preference shares can be converted to equity shares. The conversion rate is fixed, and investors can do so only after completing a pre-stipulated time as per the company's memorandum.
• Non-Convertible- The non-convertible preference shares cannot be converted to equity shares. However, they are still preferred over equity shares.
• Participating- Apart from fixed dividends, participating preference shareholders are also entitled to receive surplus profits from the company. Moreover, the shareholders enjoy voting rights on decisions related to the sale of business or liquidation of its assets.
• Non-Participating- With non-participating preference shares, you have no rights over the surplus profits of the company. However, you will still receive fixed dividends.
• Redeemable- Redeemable preference shares have a maturity date. The shareholder receives a fixed dividend up to the maturity date, and then the issuing company repurchases the shares from the shareholder. Once redeemable shares are sold to the company, the shareholder will no longer receive dividends.
• Non-Redeemable- As the name suggests, non-redeemable preference shares cannot be repurchased by the company directly from the shareholder. The shareholder will continue to receive dividends as long as he/she holds the shares.
• Adjustable- This is the only type of preference share where the dividend rates are not fixed. The rates are dependant on the market conditions.
• Cumulative- With cumulative preference shares, the company is responsible for paying outstanding dividends to the shareholders even in case of losses. In case the company cannot pay dividends in a year due to losses, the same is paid as arrears once the company makes profit along with that year’s dividends.
• Non-Cumulative- If you have non-cumulative preference shares, you are not liable to receive any outstanding dividends in arrears.

This is one of the biggest differences between equity shares and preference shares. With equity shares, the company is not liable to pay any cumulative dividends to the shareholders. It is possible for a company not to distribute dividends to its equity shareholders for years.But this is generally not possible with preference shares. Unless the company has issued non-cumulative preference shares, it is liable to pay outstanding dividends to the preference shareholders. If a company does not announce any dividends this year due to losses, the preference shareholder is liable to receive dividends in arrears in the following year.

Here is a quick overview of some of the biggest differences between the two-

Now that you know the diff between preference share and equity share , let us look at how you can invest in preference shares.There are a few different ways in which investors can purchase preference shares. For instance, you can invest in preference shares of a company at the primary level when they are issued. At times, even retail investors are also allowed to participate in primary level preference share issuance. However, in most cases, only investors with a capital of Rs. 10 lakhs -Rs. 20 lakhs are eligible to invest.In case if a company has listed its preference shares on stock exchanges such as BSE or NSE, you can purchase them directly like equity shares. ZEENCPS (717053) is one example of preference shares listed on BSE. Alternatively, you can also purchase preference shares of a company through an off-market deal with an existing investor.

While preference shares come with benefits such as a fixed rate of dividends, cumulative dividends, and preferred rights over equity investors, most such shares are not liquid. You cannot sell the preference shares on exchanges as easily as you could sell equity shares.In most cases, you will be required to hold on to your preference shares until maturity or look for a buyer for an off-market deal. Not to forget the fact that you will need at least Rs. 10 lakhs-Rs. 20 lakhs if you want to purchase preference shares at the primary level from the company.So, if you are new to the stock market, it is better to stick to equity shares. If you have the required capital and at least a few years of market experience, only then should you think about investing in preference shares.

As discussed above, preference shares come with a host of benefits. However, only experienced investors should invest in them as you might have to hold your investment for months and years. While these shares do come with preferred rights, they do have their disadvantages that you should know about before investing.If you want to invest in preference shares, do consider consulting with a professional investment advisor. Ensure that you thoroughly understand the pros and cons of investing to make the right decision.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.