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What is Difference Between Equity Shareholders and Preference Shareholders

29 Nov 2023

Introduction

  • Understanding the different types of shareholders is crucial to successfully navigating the world of corporate finance.
  • Two common categories of shareholders are equity shareholders and preference shareholders.
  • While both groups hold ownership in a company, their rights, benefits, and priorities are distinct.
  • This article delves into the differences between these two categories of shareholders to help you gain a better understanding of their roles and implications.

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Equity Shareholders

Equity shareholders, also known as common shareholders or ordinary shareholders, are individuals or entities that hold ordinary shares in a company. 

These shares represent ownership in the company and give shareholders specific rights and entitlements. Here are some key benefits that equity shareholders enjoy:

Voting rights: 

Equity shareholders have voting rights in the company's affairs. They can participate in general meetings, exercise their voting power, and have a say in important matters, such as electing the board of directors, approving significant corporate actions, and making vital decisions.

Dividend distribution: 

Equity shareholders receive dividends based on company profits, subject to profitability, financial position, and board decisions. Dividends are typically paid after preference shareholders' obligations are met.

Residual claim: 

Equity shareholders have a residual claim on the company's assets and earnings. In the event of liquidation or winding-up of the company, equity shareholders are entitled to the remaining assets after the claims of creditors and preference shareholders have been settled.

Risk and reward: 

Compared to preference shareholders, equity shareholders bear higher risks. If the company performs well, equity shareholders have the potential to earn higher returns through capital appreciation and dividend payouts. Conversely, they also face the risk of capital loss if the company's performance deteriorates.

Preference Shareholders

Preference shareholders, as the name suggests, have certain preferences or priorities over equity shareholders. They hold preference shares, which carry specific rights and privileges. Here are the key characteristics of preference shareholders:

Fixed-rate dividends: 

Preference shareholders are entitled to receive a fixed rate of dividend, usually expressed as a percentage of the face value of their shares. The dividend is paid to preference shareholders before any distribution is made to equity shareholders.

The fixed dividend provides preference shareholders with a more predictable income compared to the variable dividends received by equity shareholders.

Priority in asset distribution: 

In the event of liquidation or winding up of the company, preference shareholders have a priority claim on the company's assets over equity shareholders. They are paid back their capital investment and any unpaid dividends before any distribution is made to equity shareholders.

Limited voting rights: 

Preference shareholders generally have limited or no voting rights in the company. While they may be able to vote on specific matters that directly affect their rights, such as changes to the rights attached to preference shares, they typically do not participate in the general decision-making process of the company.

Lower risk and lower reward: 

Preference shareholders have lower risk exposure compared to equity shareholders. Their fixed dividend and priority in asset distribution provide some stability and security.

However, preference shareholders may have limited potential for capital appreciation and lower participation in the company's overall growth compared to equity shareholders.

Key Differences Between Equity and Preference Shareholders

The primary differences between equity shareholders and preference shareholders are as follows:

Voting rights: 

Equity shareholders have voting rights, while preference shareholders have limited or no voting rights.

Dividend distribution: 

Equity shareholders receive variable dividends based on the company's performance, while preference shareholders receive fixed dividends.

Asset distribution: 

Preference shareholders have priority in asset distribution during liquidation or winding up, whereas equity shareholders have a residual claim.

Risk and reward: 

Equity shareholders bear higher risk and have the potential for higher returns, while preference shareholders have lower risk and more stable income.

Conclusion

  • Equity shareholders and preference shareholders play distinct roles in a company's ownership structure. 
  • Equity shareholders have voting rights, bear higher risk, and participate in the company's residual earnings. On the other hand, preference shareholders have fixed dividends, priority in asset distribution, and lower risk exposure.
  • Understanding the differences between these two types of shareholders is vital for investors, as it helps them assess their rights, benefits, and the overall dynamics of their investments in a company.

 

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