Strategic Management and Corporate Finance · Sources of Corporate Funding

Equity Share Capital and Preference Shares: Types and Features

Updated 11 October 2026 · Fact-checked

Equity shares carry ownership, voting rights and a variable dividend, and rank last on winding up. Preference shares carry a fixed dividend and priority in dividend and capital repayment, but usually no ordinary voting rights. Companies raise them by public issue, rights issue, bonus issue, sweat equity or ESOPs. Answer by defining, listing features, then merits and demerits.

Understand Equity Share Capital and Preference Shares

A company needs long-term money. Share capital is the permanent source. It is split into equity shares and preference shares, and the two differ in risk, return and control.

Equity shares are the ownership capital. Holders are the residual owners. They get dividend only after preference dividend, and only if the board recommends it and profits or reserves allow. They get voting rights and share in surplus on winding up after all creditors and preference holders are paid. Return is uncertain, so the risk is highest. The company has no fixed repayment duty, so there is no financial strain on it.

Preference shares sit between equity and debt. Holders get a fixed rate of dividend before equity holders, and capital is repaid before equity on winding up. Types you must know:
- Cumulative: unpaid dividend carries forward to later years. Non-cumulative: it lapses.
- Participating: also share in surplus profits or surplus assets beyond the fixed rate. Non-participating: only the fixed rate.
- Convertible: can be turned into equity on set terms. Non-convertible: cannot.
- Redeemable: repaid after a fixed period. Irredeemable: not repaid during the company's life. Under the Companies Act, 2013 a company cannot issue irredeemable preference shares, and redeemable ones must be redeemed within 20 years (a longer period is allowed only for infrastructure projects, as the Act provides).

Preference holders have voting rights only on matters directly affecting their rights, or if dividend has been unpaid for the period the Act specifies. Dividend on preference shares is a distribution of profit, not a tax-deductible expense like interest.

Other equity routes: a public issue (IPO for an unlisted company, FPO for a listed one), a rights issue to existing holders in proportion to their holding, a bonus issue that capitalises reserves into free shares, sweat equity for employees and directors for know-how or value addition, and ESOPs, which give employees an option to buy shares at a fixed price after a vesting period. A rights issue and a public issue bring in cash. A bonus issue brings in none. Sweat equity is issued for non-cash consideration, and ESOPs bring cash when the option is exercised.

Key rules to remember

Equity vs preference: core test: Dividend: preference first, at a fixed rate; equity after, variable. Capital on winding up: preference before equity.; Use this as the base of any difference answer.
Value of a right (theoretical ex-rights price): Ex-rights price = (N × Market price + R × Issue price) ÷ (N + R); Value of a right = Cum-rights price − Ex-rights price; N = existing shares held per unit, R = new shares offered per unit. It is a theoretical price and ignores market movements.
Bonus issue effect: Total equity (share capital + reserves) is unchanged; share capital rises and reserves fall by the same amount.; No cash comes in. Ex-bonus market price tends to fall, but this is not a fixed rule.
Cumulative preference arrears: Arrears = Fixed dividend per year × Number of unpaid years; Applies only to cumulative preference shares.
Redemption limit for preference shares: Redeemable within 20 years; irredeemable preference shares cannot be issued; Longer period is allowed only for infrastructure projects, subject to the Act's conditions.

How to solve Equity Share Capital and Preference Shares questions

Use this order for any theory or case question on equity, preference, rights, bonus, sweat equity or ESOPs.

1Identify the instrument or route the question asks about and define it in one or two lines.
2State the key features: rights, dividend, voting, repayment and ranking on winding up.
3If the question asks for types, classify with a clear basis (cumulative, participating, convertible, redeemable) and give one line on each.
4For issue routes (rights, bonus, sweat equity, ESOP), state whether cash comes in, who is eligible and what the main condition is.
5Apply to the facts given in the case, such as the company's need, its control concerns and its cash position.
6Give merits and demerits, or a comparison, in two balanced columns written as points.
7Close with a reasoned conclusion that fits the company's situation.

Quickest way: Compare on five heads

When to use it: For difference questions and short notes when time is tight.

Write the five heads: dividend, voting, repayment or priority, risk, convertibility or control.
Fill one line for each instrument under every head.
Add one merit and one demerit from the company's point of view.
For rights, bonus, sweat equity and ESOP, add a one-line note on whether cash comes in.
Finish with a one-line conclusion tied to the facts.

Common mistakes in Equity Share Capital and Preference Shares

Saying preference shareholders never have voting rights.
Students remember the general rule and drop the exception.
Fix: Write that they vote on matters affecting their rights and when dividend is unpaid for the period the Act specifies.
Treating preference dividend as a legal duty like interest.
The dividend is fixed, so it looks like debt.
Fix: State that it is paid out of profits when declared. Cumulative shares only carry arrears forward.
Writing that a bonus issue raises funds.
Both rights and bonus add shares, so they get mixed up.
Fix: Say a bonus issue only capitalises reserves. Total net worth is unchanged and no cash is received.
Mixing sweat equity with ESOP.
Both reward employees with shares.
Fix: Sweat equity is issued at a discount or for non-cash consideration such as know-how. An ESOP is an option, exercised after vesting at a pre-set price.
Listing types of preference shares without a basis.
Students recall names but not the grouping.
Fix: Group by dividend (cumulative), participation, conversion and redemption, and give a one-line meaning of each.
Forgetting the 20-year redemption limit.
It is a small detail in the notes.
Fix: Add it whenever you discuss redeemable preference shares, and mention the infrastructure exception.

Worked examples

Example 1

Meena Textiles Ltd has 10,00,000 equity shares. It offers a rights issue of 1 share for every 4 held at ₹80 per share. The cum-rights market price is ₹100. Compute the theoretical ex-rights price and the value of a right.

Show the solution

Take 4 existing shares and 1 new share, so N = 4 and R = 1.
Value of 4 old shares at market price = 4 × ₹100 = ₹400.
Cost of 1 new share = ₹80.
Total value of 5 shares = ₹400 + ₹80 = ₹480.
Ex-rights price = ₹480 ÷ 5 = ₹96.
Value of a right = ₹100 − ₹96 = ₹4.

Answer: Theoretical ex-rights price is ₹96 per share and the value of a right is ₹4 per share.

Example 2

Distinguish between equity shares and preference shares, and name the types of preference shares, for a company that wants capital without diluting control.

Show the solution

Define equity shares as ownership capital with voting rights and a variable dividend, ranking last on winding up.
Define preference shares as capital with a fixed dividend and priority over equity in dividend and repayment.
Compare: dividend is variable for equity and fixed for preference; voting is full for equity and limited for preference; risk is highest for equity; preference may be redeemable or convertible, while equity is permanent.
List the types: cumulative and non-cumulative, participating and non-participating, convertible and non-convertible, redeemable (irredeemable ones cannot be issued).
Apply to the facts: a company wanting to protect control can issue non-convertible redeemable preference shares, which carry no ordinary voting rights and do not dilute control.
Note the demerit: a fixed dividend burden, and dividend is not tax deductible.

Answer: Equity is risk capital with control; preference is a fixed-return, priority instrument. To avoid dilution, the company should use non-convertible redeemable preference shares, redeemable within 20 years.

Exam tips

Difference questions score on a clean point-by-point comparison. Use at least five heads.
Always add the Companies Act, 2013 position on redemption and voting for preference shares.
In case questions, link the choice of instrument to the company's need for cash, control and cost.
For rights price questions, show the formula, the substitution and the final value separately.
Give a one-line conclusion; markers reward a reasoned recommendation.

Practice questions from Sources of Corporate Funding

Equity Share Capital 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 Share Capital and Preference Shares: frequently asked questions

What is the main difference between equity and preference shares?

Equity holders own the company, vote and get a variable dividend after everyone else. Preference holders get a fixed dividend first and capital back before equity, but have limited voting rights.

What are the types of preference shares?

They are cumulative or non-cumulative, participating or non-participating, convertible or non-convertible, and redeemable. Irredeemable preference shares cannot be issued under the Companies Act, 2013.

How is a rights issue different from a bonus issue?

A rights issue offers new shares to existing holders for cash, usually at a price below market, so it raises funds. A bonus issue gives free shares out of reserves, so no cash comes in and net worth is unchanged.

What is the difference between sweat equity and ESOP?

Sweat equity shares are issued to employees or directors at a discount or for non-cash consideration such as know-how. An ESOP gives employees the option to buy shares at a pre-fixed price after a vesting period.