Financial Management and Business Data Analytics · Sources of Finance

Equity Shares and Preference Shares: Features, Types and Differences

Updated 10 October 2026 · Fact-checked

Equity shares represent ownership with voting rights, no fixed dividend and the last claim on profits and assets. Preference shares carry a fixed dividend and a priority claim over equity but usually no voting rights. To answer questions, state the feature, type, advantage and limitation, then compare the two on dividend, voting, repayment and risk.

Understand Equity Shares and Preference Shares

A company raises long-term money from owners and lenders. Share capital is the owners' money. It has two main forms: equity shares and preference shares.

Equity shareholders are the real owners. They get dividend only if the company declares it, and the amount is not fixed. They carry the highest risk. In winding up they are paid last, from what remains. In return they have voting rights and enjoy all the upside when the company grows. Equity is permanent capital: it is not repaid during the life of the company, except through a buyback or capital reduction as allowed by law.

Preference shareholders rank ahead of equity for dividend and for repayment of capital. Their dividend is at a fixed rate. They normally have no voting rights, except in limited situations set by company law, such as when their own rights are affected. They bridge the gap between debt and equity, so they are called a hybrid source. Dividend on them is paid out of profit after tax and is not tax deductible, unlike interest.

Types of preference shares:
- Cumulative: unpaid dividend of a year is carried forward and paid before any equity dividend later. Non-cumulative lose it.
- Participating: besides the fixed dividend, they share in surplus profit with equity. Non-participating get only the fixed rate.
- Convertible: can be converted into equity shares after a set period. Non-convertible cannot.
- Redeemable: repaid after a fixed period or at the company's option. Irredeemable (perpetual) preference shares are not permitted for companies under the Companies Act, 2013. A company cannot issue preference shares redeemable after 20 years, except companies engaged in infrastructure projects. These may issue them for more than 20 years, subject to prescribed conditions, including redemption in instalments.

Special ways of issuing equity:
- Rights issue: new shares offered first to existing shareholders in proportion to their holding, usually at a price below market. Shareholders can take up, sell (renounce) or ignore the right. It protects control and avoids full public issue costs.
- Bonus shares: free shares issued to existing shareholders out of free reserves or securities premium by capitalising them. No cash comes in. Reserves fall and share capital rises by the same amount, so total net worth is unchanged. The number of shares rises and the market price per share tends to fall.
- Sweat equity shares: shares issued at a discount or for consideration other than cash, for providing know-how or making available rights in the nature of intellectual property rights or value additions, to directors or employees. They reward and retain key people.

Advantages of equity: no fixed burden of dividend, permanent capital, raises borrowing capacity, no charge on assets. Limitations: highest cost of capital, dividend not tax deductible, dilution of control and earnings per share, and issue costs are high. Advantages of preference: no dilution of control, fixed dividend can give trading on equity, dividend can be skipped without default (more so for non-cumulative). Limitations: costlier than debt, no tax shield, cumulative arrears become a burden, and investors may find the instrument unattractive without voting rights.

Key rules to remember

Rights issue: theoretical ex-rights price: Ex-rights price = (N × Cum-rights price + R × Issue price) ÷ (N + R); N = old shares held for the offer; R = new shares offered against them. Use the market price just before the issue as cum-rights price.
Value of a right: Value of right per new share = Cum-rights price − Ex-rights price (with one new share offered per right); For the value per old share held, divide the total gain by N old shares. State clearly which one you compute.
Bonus issue accounting: Bonus capitalised = Number of bonus shares × Face value; Debit free reserves or securities premium, credit equity share capital. Net worth stays the same.
Ex-bonus price (approximate): Ex-bonus price = Cum-bonus price × Old shares ÷ (Old shares + Bonus shares); Assumes market capitalisation does not change. It is a theoretical estimate.
Preference dividend: Preference dividend = Rate × Face value × Number of shares; For cumulative shares add arrears for the years missed.
Sweat equity discount: Discount = Fair value of share − Issue price; The discount is the benefit given to the employee for contribution made.

How to solve Equity Shares and Preference Shares questions

Questions on this topic are either theory (features, types, differences, merits) or short numerical (rights, bonus, preference dividend). Use this method.

1Read the verb: 'explain', 'differentiate', 'discuss merits' or 'calculate'. This tells you the format.
2For theory, define the instrument in one line, then list features, types and advantages and limitations in separate short headings.
3For differences, draw two columns and compare on dividend, voting, repayment, claim on assets, risk, cost, tax treatment and control.
4For rights or bonus numericals, write the given data: shares held, ratio, issue price, market price.
5Apply the correct formula: ex-rights price for rights, capitalisation of reserves for bonus.
6Show each step with units (₹ per share, number of shares) and check that total value before and after is consistent.
7Finish with one line of interpretation, such as effect on wealth of a shareholder or on control.

Quickest way: Compare-and-calculate shortcut

When to use it: Use when you have little time, especially in MCQs and 2 to 4 mark short notes.

For MCQs, link keywords: 'fixed dividend and priority' means preference; 'ownership and residual claim' means equity; 'free shares from reserves' means bonus; 'offer to existing holders' means rights; 'employees for know-how' means sweat equity.
For rights, find total value: (N × market price) + (R × issue price), divide by (N + R).
For bonus, price falls in the ratio old shares ÷ total shares; shareholder wealth stays unchanged.
For preference dividend, multiply rate, face value and shares; add arrears only if cumulative.

Common mistakes in Equity Shares and Preference Shares

Saying bonus shares bring cash into the company or increase shareholder wealth.
Students link any share issue with raising funds.
Fix: Remember bonus is a book entry from reserves to capital. Net worth and total market value stay the same; only the number of shares changes.
Treating preference dividend as an expense that saves tax.
Preference shares are confused with debentures because the rate is fixed.
Fix: Preference dividend is an appropriation of profit after tax. Only interest on debt is deductible.
Using the issue price instead of the market price as cum-rights price.
Both prices appear in the question and students pick the wrong one.
Fix: Cum-rights price is the market price before the rights offer. The issue price is the price of the new shares.
Mixing cumulative with participating preference shares.
Both words describe extra benefits and sound alike.
Fix: Cumulative is about carrying forward unpaid dividend. Participating is about sharing surplus profit beyond the fixed rate.
Writing that preference shareholders never have voting rights.
Textbooks say 'no voting rights' as a general point.
Fix: Write 'normally no voting rights, except on matters affecting their own rights as provided by law'.
Describing rights issue as an offer to the general public.
Rights issue is confused with public issue.
Fix: A rights issue is offered first to existing shareholders in proportion to their holdings.

Worked examples

Example 1

A company's shares trade at ₹150 each. It offers a rights issue of 1 new share for every 4 shares held, at ₹110 per share. Calculate the theoretical ex-rights price and the value of a right per new share.

Show the solution

N = 4 old shares, R = 1 new share.
Total value = (4 × ₹150) + (1 × ₹110) = ₹600 + ₹110 = ₹710.
Total shares = 4 + 1 = 5.
Ex-rights price = ₹710 ÷ 5 = ₹142.
Value of a right per new share = ₹150 − ₹142 = ₹8.

Answer: Ex-rights price is ₹142 per share. The value of a right is ₹8 per new share.

Example 2

A company has 10,00,000 equity shares of ₹10 each fully paid and free reserves of ₹80,00,000. It issues bonus shares in the ratio 1:5. The market price before the bonus is ₹60. Find the bonus amount capitalised, the new number of shares and the expected ex-bonus price. Also state the effect on a holder of 500 shares.

Show the solution

Bonus shares = 10,00,000 × 1 ÷ 5 = 2,00,000 shares.
Amount capitalised = 2,00,000 × ₹10 = ₹20,00,000, taken from free reserves.
Free reserves after bonus = ₹80,00,000 − ₹20,00,000 = ₹60,00,000.
Share capital after bonus = ₹1,00,00,000 + ₹20,00,000 = ₹1,20,00,000; new shares = 12,00,000.
Ex-bonus price = ₹60 × 5 ÷ 6 = ₹50.
Holder of 500 shares gets 100 bonus shares, so holds 600 shares.
Value before = 500 × ₹60 = ₹30,000. Value after = 600 × ₹50 = ₹30,000.

Answer: ₹20,00,000 is capitalised; shares become 12,00,000; expected ex-bonus price is ₹50. The shareholder's wealth stays at ₹30,000, with 600 shares instead of 500.

Exam tips

Differences between equity and preference shares are asked often. Prepare a table with at least six points and learn it.
In short notes on rights, bonus or sweat equity, write meaning, purpose, effect on control and one limitation.
For numericals, always show the formula and substitute values. Step marks are given even if the final answer slips.
Read MCQ options carefully: cumulative, participating, convertible and redeemable are easy to swap.
Mention the hybrid nature of preference shares when comparing sources of finance.

Practice questions from Sources of Finance

Equity Shares and Preference Shares in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Equity Shares and Preference Shares: frequently asked questions

What is the main difference between equity shares and preference shares?

Equity shareholders are owners with voting rights, variable dividend and a residual claim. Preference shareholders receive a fixed dividend and are paid before equity, but normally cannot vote. Equity carries more risk and expects higher returns.

Do bonus shares increase shareholder wealth?

No. Bonus shares only convert reserves into share capital. The number of shares rises and the price per share falls, so total value of the holding stays about the same.

What is the difference between cumulative and participating preference shares?

Cumulative shares let unpaid dividend carry forward to later years. Participating shares share in surplus profits along with equity after the fixed dividend is paid. They deal with different rights.

Why are sweat equity shares issued?

They are issued to employees or directors at a discount or for consideration other than cash, for know-how, intellectual property rights or value additions. The aim is to reward and retain people who add value to the company.