Understanding Preferred vs Normal Equity Shares: When novice investors enter the world of investing they are bombarded with multiple investing jargon. Just as he gets around to understanding what a share is, he is again told that there are two different types of shares, Preferred and Normal Equity Shares.
In this article, we try to understand what are Preferred and Normal Equity Shares. Moreover, we’ll look into what’s the basic difference between Preferred vs Normal Equity Shares. Keep Reading to find out.
What are Equity Shares?
When we talk about equity shares, we refer to the normal or ordinary shares available in the market. If you hold these shares you are one of the owners of the company to the extent of capital invested.
Equity shareholders have the privilege to have voting rights on important matters of the company at the general meeting. They also have the authority to control the affairs of the business.
As an owner, they also bear the risk of investing in the company. For this, they are rewarded through means of profits or capital appreciation. The profits remaining after the expenses and other liabilities of the company are paid off are transferred to the equity shareholders in the form of dividends after approval from the company’s board. The more profits a company makes the more profit is transferred to the equity shareholders and vice versa.
The owners can also transfer the ownership of their shares whenever they want in the secondary markets. This also gives equity shareholders added liquidity. For the company equity shares are one of the most primary sources to raise capital.
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What are Preferred Shares?
One of the easiest ways to understand Preferred shares is through the name. They are known as preference shares because their holders get preferential treatment over equity shareholders.
This preferential treatment is given when profits are distributed as dividends. Preference shareholders are paid a fixed rate every year before equity shareholders get the remaining profits. In terms of preference these shareholders have more priority than equity but are ranked below debt.
The preferred shareholders, however, do not have any voting rights in the company. They do have a right to vote only in cases where their rights as preference shareholders are affected or in the case of winding up the company and reducing capital. Preferred shareholders cannot exert any influence over the decision a company takes.
Here are some more types of preference shares:
- Participating Preference Shares
- Non-Participating Preference Shares
- Convertible Preference Shares
- Non-Convertible Preference Shares
- Cumulative Preference Shares
- Non-Cumulative Preference Shares
Difference between Preferred vs Normal Equity Shares
Equity Shares cannot be converted into preference shares. Preference shares on the other hand can be converted into equity shares unless they are specifically issued as non-convertible preference shares.
When the company finds itself in a good position it can go ahead and redeem preference shares. On the other hand equity shares cannot be redeemed.
3) Voting Rights
Equity shares have an inherent right to vote. Preference shares on the other hand do not carry voting rights. Equity shareholders have the authority to vote in all matters but preference shareholders can only do so in matters that concern them.
4) Management Participation
Equity shareholders also can participate in the management of the company depending on the ownership held. However, preference shareholders have no control or influence over the management.
5) Dividend Payment
Payment of dividends is not compulsory to equity shareholders. If the company makes profits it is at the discretion of the management and board to transfer these profits over to the equity shareholders. These profits can also be held back and reinvested into the business. In the case of preference shares, they have to be paid dividends if the company makes profits.
6) Dividend Rate
The rate of dividend is not fixed when it comes to equity shareholders. They are paid at the rate agreed upon depending on the year and the company’s objectives. The rate of dividend payable to preference shareholders is decided when the shares are issued. Every year they are paid at this rate.
In the case of preference shares if the company makes a loss it still has to pay the dividend at some time in a later period when the company makes a profit along with the profits for that respective year. This is the case unless the shares are specifically issued as non-cumulative preference shares. Equity shares do not have this benefit as there is no obligation to pay dividends.
In a case where the company is winding up, the preference shareholders are once again given preferential treatment before equity shareholders.
Buying Preferred vs Normal Equity Shares?
Preference shares can be bought through private placements or in a public issue. In the case of a private placement, the minimum amount set for one to invest is Rs. 10 Lakh. On the other hand, Equity shares can be bought and sold regularly in the secondary market or through IPOs.
At the end of the day, both preference and equity shares are good investment instruments. It all comes down to the investors’ preferences and risk appetite. As mentioned above, common shareholders are last in line when the company is going in for liquidation. However, it is more general to buy normal equity shares over the preferred shares.
That’s all for this post on the difference between preferred vs normal equity shares. Let us know about your preference and reasons in the comments below. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.