Difference Between Preference Share Capital and Equity Share Capital

Share capital is the foundation of a company’s financial structure. Under the Companies Act, 2013, companies raise funds primarily through equity share capital and preference share capital. Both forms of capital serve different purposes, carry distinct rights, and create different relationships between the company and its shareholders. Understanding the difference between preference share capital and equity share capital is essential for analysing corporate finance, shareholder rights, and company management.

Meaning of Share Capital

Share capital refers to the amount of money raised by a company through the issue of shares. It represents the ownership interest in the company and forms an important part of its capital structure. Broadly, share capital is divided into equity share capital and preference share capital.

What is Equity Share Capital?

Equity share capital refers to the capital raised by issuing equity shares, also known as ordinary shares. These shares represent ownership in the company and entitle shareholders to participate in its profits and management.

Equity shareholders are considered the real owners of the company. Their returns depend on the profitability of the company, and they bear the highest level of risk among all shareholders. Equity share capital is a long-term source of finance and cannot be redeemed during the lifetime of the company, except through procedures such as reduction of capital.

Features of Equity Share Capital

• Ownership Rights: Equity shareholders are part owners of the company. Their ownership is proportionate to the number of shares held.
• Voting Rights: Equity shareholders have the right to vote on all matters affecting the company, including appointment of directors, mergers, and policy decisions.
• Variable Dividend: Dividend on equity shares is not fixed. It depends on the profits of the company and is declared at the discretion of the board of directors.
• Residual Claim: In case of winding up, equity shareholders receive payment only after all liabilities and preference shareholders are paid.
• Non-redeemable Nature: Equity shares are not redeemable during the company’s lifetime, making them a permanent source of capital.

Equity share capital plays a crucial role in corporate governance, as it provides control and decision-making power within the company.

What is Preference Share Capital?

Preference share capital refers to that part of the issued capital of a company which carries preferential rights with respect to payment of dividend and repayment of capital. This is defined under Section 43(2) of the Companies Act, 2013.

Preference shareholders enjoy priority over equity shareholders in two major aspects:

• Payment of dividend at a fixed rate or fixed amount
• Repayment of capital in the event of winding up

However, preference shareholders generally do not enjoy voting rights in the management of the company, except in certain specific circumstances.

Features of Preference Share Capital

• Preferential Dividend: Preference shareholders receive dividend before equity shareholders. The rate of dividend is usually fixed.
• Priority in Repayment: In case of liquidation, preference shareholders are paid before equity shareholders.
• Limited Voting Rights: Preference shareholders do not participate in general management decisions, except where their rights are affected.
• Redeemable Nature: Preference shares can be redeemed within a specified period, subject to the provisions of the Companies Act, 2013.
• Lower Risk: Due to fixed returns and priority rights, preference shares are generally less risky compared to equity shares.

Preference share capital is often considered a hybrid form of financing, as it has characteristics of both equity and debt.

Key Differences Between Preference Share Capital and Equity Share Capital

The distinction between preference share capital and equity share capital can be understood through the following comparative analysis:

Nature and Definition

Equity share capital represents ownership in the company and provides residual rights in profits and assets. Preference share capital, on the other hand, represents capital that carries preferential rights in terms of dividend and repayment.

Dividend Rights

Equity shareholders receive dividends only after preference shareholders have been paid. The dividend on equity shares is not fixed and depends on the company’s profitability.

Preference shareholders are entitled to a fixed rate of dividend, which is paid before any dividend is distributed to equity shareholders. In the case of cumulative preference shares, unpaid dividends accumulate and must be cleared before equity dividends are paid.

Voting Rights

Equity shareholders enjoy full voting rights on all matters affecting the company. This gives them control over management decisions and corporate policies.

Preference shareholders generally do not have voting rights, except in special circumstances such as when their rights are affected or when dividends remain unpaid for a specified period.

Priority in Winding Up

In the event of winding up, preference shareholders have priority over equity shareholders in the repayment of capital. Equity shareholders receive the remaining assets only after all liabilities and preference shareholders have been satisfied.

Redemption

Equity shares are not redeemable during the lifetime of the company, making them a permanent source of capital.

Preference shares are redeemable within a specified period, as per Section 55 of the Companies Act, 2013. This makes preference share capital a temporary source of finance.

Risk and Return

Equity shareholders bear higher risk, as their returns depend entirely on the performance of the company. However, they also have the potential for higher returns through capital appreciation and higher dividends.

Preference shareholders face lower risk due to fixed dividends and priority rights. However, their returns are limited and do not increase with the company’s profits, unless the shares are participating in nature.

Participation in Management

Equity shareholders actively participate in management through voting rights and influence over corporate decisions.

Preference shareholders do not participate in the management of the company and have limited influence over its operations.

Accumulation of Dividends

Equity shares do not provide for accumulation of unpaid dividends. If a dividend is not declared, equity shareholders cannot claim it in future.

Preference shares, in the case of cumulative preference shares, allow accumulation of unpaid dividends, which must be paid in subsequent years.

Convertibility

Equity shares cannot be converted into preference shares without following the procedure for reduction of capital.

Preference shares, particularly convertible preference shares, can be converted into equity shares subject to the terms of issue.

Financing Role

Equity share capital is primarily used for long-term financing and provides stability to the company’s capital structure.

Preference share capital is used for medium-term or long-term financing and provides flexibility due to its redeemable nature.

Conclusion

Preference share capital and equity share capital are two essential components of a company’s financial structure, each serving distinct purposes. Equity share capital represents ownership, control, and potential for higher returns, while preference share capital offers stability, fixed returns, and priority in dividend and capital repayment.

The Companies Act, 2013 provides a clear legal framework governing both types of share capital, including provisions relating to dividend rights, redemption, and conversion. The choice between equity and preference shares depends on the objectives of the company and the risk-return expectations of investors.