Preference and equity capital are two main types of capital a company can raise by issuing shares. Each has distinct characteristics that impact ownership, control, and returns for investors.
Equity Capital:
- Represents ownership: Equity shareholders are considered part owners of the company. The number of shares owned determines the ownership stake.
- Voting rights: Equity shareholders have voting rights on crucial matters like electing the board of directors and approving major business decisions. This allows them to influence the company’s direction.
- Dividend payouts: Equity shareholders receive dividends, a portion of the company’s profits, if and when declared by the board. However, dividend payouts are not guaranteed.
- Profit potential: Equity shareholders enjoy the potential for higher returns if the company performs well and its stock price increases.
- Higher risk: Equity capital is considered riskier because shareholders are last in line to receive payment if the company dissolves. They only receive any remaining assets after all debts and obligations are settled.
Preference Capital:
- Priority over dividends: Preference shareholders have a preferential right to receive dividends before any dividends are paid to equity shareholders. The dividend rate is usually fixed.
- Limited or no voting rights: Preference shareholders typically have limited or no voting rights on company matters. They don’t have a say in management decisions.
- Priority in liquidation: In the event of company liquidation, preference shareholders have priority over equity shareholders in receiving their capital investment back. However, they rank behind debt holders.
- Stable income: Preference shares offer a more predictable income stream due to the fixed dividend.
- Lower potential for capital appreciation: Preference shares typically have lower potential for growth in share price compared to equity shares.
Choosing Between Preference and Equity Capital:
The choice between preference and equity capital depends on the company’s needs and the investor’s risk tolerance:
- Companies: Companies might issue preference shares to attract investors seeking a steady income without diluting ownership control (voting rights). Equity capital is ideal for raising funds when future growth prospects are high.
- Investors: Investors with a lower risk appetite might prefer preference shares for their fixed income and priority in repayment. Equity shares are suitable for investors seeking potential for high returns and a role in company decisions, but they come with higher risk.
By understanding the characteristics of preference and equity capital, companies can make informed financing decisions, and investors can choose the share type that best aligns with their financial goals.