The dynamic world of corporate finance has always fascinated with its blend of strategy, risk, and reward. Companies, whether newly established or seasoned, frequently utilise a variety of financing options to meet their capital requirements. Among the plethora of options available, issuing shares remains one of the most popular methods to raise capital. Two primary types of shares prevalent in the Indian market are equity shares and Preference shares. This article dives into the difference between equity and preference shares, why companies opt for both, and the intricacies involved in this decision-making process.
Table of Contents
Difference Between Equity and Preference Shares
Before understanding why companies issue both forms of shares, it is pivotal to first grasp the fundamental difference between equity and preference shares.
Equity Shares
These shares represent ownership in the company. Holders of equity shares have voting rights and the dividend paid to them is variable, based on the company’s profitability. Equity shareholders come last in the line during liquidation scenarios, meaning they only get paid after all debts and liabilities have been settled. This makes equity more risky but potentially more rewarding.
Preference Shares
Preference shares come with preferential rights regarding dividends and asset liquidation. Holders of these shares receive dividends at a fixed rate before any dividend is paid to equity shareholders. In the event of liquidation, they have a superior claim over assets compared to equity shareholders, making them less risky. However, preference shareholders usually do not have voting rights, limiting their influence over corporate decisions.
Why Companies Issue Both Types of Shares
The decision to issue both equity and preference shares hinges on several strategic financial considerations:
Capital Requirement Versatility
Companies often require different forms of capital depending on their growth stage, operational needs, or market ambitions. Equity shares appeal to companies when striving for substantial equity to fund expansive projects or foster growth. In contrast, Preference shares might be issued when aiming for a steady cash inflow without diluting control, given that preference shareholders typically lack voting rights.
Balance Between Risk and Reward
Issuing both types allows companies to balance risk and reward framed by investor profiles. Preference shares attract risk-averse investors seeking stable returns, whereas equity shares draw in those who are less averse to risk for potentially higher returns.
Market Conditions and Trends
Companies often consider prevailing economic conditions and market trends when deciding their share offering structure. An analysis of trending financial strategies might reveal periods where preference shares, due to their fixed dividends and perceived security, are more attractive to investors, impacting the company’s decision.
Cost of Financing
Equity can be a costlier source of capital due to dividend payouts and potential dilution of control, whereas preference shares offer more fixed financial commitments. Companies weigh these factors when considering the cost-effectiveness of each share type.
Present Financial Calculations in INR
To illustrate the implications of issuing both equity and preference shares, let’s consider two simplified scenarios for a hypothetical company:
Scenario 1: Equity Issuance
A company issues 10,000 equity shares at INR 100 each, raising INR 1,000,000. If we assume the company’s profit translates to a 10% dividend yield, the cash payout is:
Dividend Payment = 10,000 shares × ₹100 × 10% = ₹100,000
Post-dividend, investors benefit from potential share price appreciation but face higher risk due to profit variability.
Scenario 2: Preference Share Issuance
The same company issues 5,000 preference shares at INR 100 each with a fixed dividend of 8%. Total capital raised is INR 500,000. The dividend obligation per year is:
Dividend Payment = 5,000 shares × ₹100 × 8% = ₹40,000
This predictable payout provides less risk, though without growth in payout potential, appealing to conservative investors.
Balancing Strategic Control and Financing Costs
From a strategic perspective, issuing equity involves the potential loss of control due to its voting rights. Companies may resort to Preference shares to avoid this dilution while still attracting capital. The key challenge is balancing financing costs with control, as equity might require higher payouts but confers shareholder governance abilities.
Corporate Strategy in Practice
Many leading corporations utilise a blend of equity and preference shares to optimise their financial strategy. An illustrative approach is blending equity’s growth potential with preference’s stability in uncertain market conditions. This dual offering is pivotal for accommodating varying risk appetites, providing flexibility for the company while securing diverse investment streams.
Disclaimer
Engaging with the stock market, whether through trading equity or preference shares, includes inherent risks. It is essential for investors to analyse all aspects, including personal risk tolerance, market trends, and long-term potential, when making investment decisions in the Indian stock market. This article provides information and examples intended for understanding only, and investors should conduct thorough research or consult with financial advisors when forming investment strategies.
Conclusion
The dual issuance of equity and preference shares is a trending, strategic choice leveraged by companies for capital acquisition while maintaining corporate control and appealing to diverse investor bases. Understanding the difference between equity and preference shares is essential for both investors and companies navigating the complexities of market dynamics and financial strategy. Through calculated issuance, companies can optimise their capital structure to meet strategic goals efficiently while investors can align their investment portfolios with personal financial objectives and risk affinities in the Indian stock market landscape.
