difference between equity shares and preference shares and debentures
Answers
What is the difference between debenture, preference, and equity shares?
All three of these are items of liability and equity through which companies raise funds for it’s operations. However they differ from each other by the following facts :
(I) Debenture is an acknowledgement of a debt by the company. Or simply, it means that a company is indebted to a person who is holding a debenture of that company. The holder of debenture is entitled to receive interest on a timely basis BUT THE POSSESSION OF DEBENTURE DOES NOT MAKE HIM A MEMBER OF THE COMPANY. Such interest will be paid to debenture holders even if the company is suffering a loss. Debentures are treated as either a non current liability or a current liability, according to their tenure for maturity.
(II) Preference Share is a category of the share capital of a company which gives some preferential rights to it’s holder over that of an equity share holder. Few of such preferential rights are :
(a) payment of dividend before payment of the same to equity shareholders
(b) accumulation of unpaid dividends (during years of loss) in case of cumulative preference shares
(c) prior claim over the assets of company in case of liquidation
(III) Equity Shares undertake the maximum risk associated with a business venture since it’s holders are those category of members who will get benefited (get paid) only after paying off all the other liabilities INCLUDING preference share holders. They form the primary category of owners’ equity and also hold the right to vote during the general meetings of the company which, preference shareholders DO NOT USUALLY HOLD.
The following are some of the differences between equity shares and debentures
1. Motive of issue
Equity Shares: Equity shares are issued to meet long term financial requirements.
Dividend: Dividend are issued to meet long term and medium term financial requirements.
2. Investor preference
Equity Shares: Generally equity shares are preferred by adventurous investors with risk bearing capacity.
Dividend: Dividend are preferred by cautious investors who are reluctant to take risks.
3. Return
Equity Shares: Returns (dividends) are not fixed. They are dependent on the profits earned. High returns in case of high profits and low return in case of low profits.
Dividend: Returns (interest) are fixed in nature.
4. Priority in return
Equity Shares: They are residual claimants. They can expect dividends only after interest has been paid on debentures and preference dividend has been paid to preference shareholders.
Dividend: Interest has to be paid to them before any dividend can be distributed.
5. Settlement of claims during liquidation
Equity Shares: Their claims will be settled only after the claims of preference shareholders and debenture can be distributed to holders have been settled.
Dividend: Their claims have to be settled before anything preference or equity shareholders.
6. Financial burden
Equity Shares: Payment of equity dividends is optional. It is dependent on the discretion of the Board of Directors. Therefore there is no fixed financial commitment.
Dividend: Payment of interest on debentures is a fixed financial commitment.
7. Redemption
Equity Shares: No redemption until liquidation.
Dividend: Redeemable as per terms of issue.
8. Voting rights
Equity Shares: Enjoy voting rights
Dividend: Do not enjoy voting rights.
9. Reduction of capital
Equity Shares: Reduction of Capital is done by reorganization.
Dividend: Reduction of Capital is done by repayment.
10. Price
Equity Shares: Generally of lower denomination.
Dividend: Generally of higher denomination
11. Type of investors.
Equity Shares: Even small investors can invest because of the lower denomination
Dividend: Preferred by medium and large investors. Small investors would find it difficult to invest because of the higher denomination
12. Borrowing capacity
Equity Shares: Strengthens borrowing capacity.
Dividend: Reduces borrowing capacity.
13. Capitalization
Equity Shares: There are chances for over-capitalization.
Dividend: Lesser chances for over-capitalization.
14. Charge on assets
Equity Shares: Does not create charge on the assets.
Dividend: Generally creates charge on the assets of the company.
Preference Shares:
1. Preference Shares are entitled to a fixed rate of dividend
2. Dividend on preference shares is paid in priority to the equity shares.
3. Preference share have preference as regards to refund of capital over equity capital.
4. Redeemable Pref. share are redeemed by the company on expiry of the stipulated period.
5. A company cannot issue bonus shares and rights shares to preference share holders.
6. Voting right of preference shares is restricted.
7. These shares can be converted.
8. Arrears of dividend may accumulate in certain cases.
9. No right to participate in management