The difference between preference and ordinary shares lies in their ownership rights, dividend distribution, and risk exposure. The preference shares give fixed dividends and priority over ordinary shares during liquidation, while ordinary shares give voting rights and a claim on residual profits. Understanding the difference between these two is important for investors and companies when it comes to raising or investing capital.
What is Preference Shares?
Preference shares, also known as preferred shares, are a class of shares that offer specific privileges to shareholders. These shares provide a fixed dividend and have priority over ordinary shares when it comes to profit distribution and asset claims during liquidation.
Key Features of Preference Shares
Preference shares are a type of equity that provides investors with fixed returns and specific privileges over ordinary shareholders. They balance lower risk with limited rights, making them appealing to conservative investors.
- Fixed Dividend: Preference shareholders receive dividends at a predetermined rate before any dividends are paid to ordinary shareholders.
- Priority in Liquidation: Regarding company liquidation, preference shareholders have a prior claim on the company’s assets over ordinary shareholders.
- Limited Voting Rights: Preference shareholders generally do not have voting rights unless their dividend payments are in arrears.
- Types of Preference Shares: Cumulative: Unpaid dividends accumulate and are paid later. Non-Cumulative: Dividends do not accumulate if missed. Convertible: Can be converted into ordinary shares. Non-Convertible: Cannot be converted into ordinary shares.
What is Ordinary Shares?
Ordinary shares, also called equity shares, represent ownership in a company and provide shareholders with voting rights and a claim on residual profits after all obligations are met. These shares carry higher risks but also higher potential rewards.
Key Features of Ordinary Shares
Ordinary shares represent ownership in a company, offering voting rights and potential for high returns, though with greater risk and variable dividends.
- Voting Rights: Ordinary shareholders can vote on significant company decisions, such as electing directors and approving mergers.
- Variable Dividends: Dividends are not fixed and depend on the company’s profitability.
- Residual Claim: In liquidation, ordinary shareholders are paid after creditors and preference shareholders.
- High Risk and Reward: Returns are tied to the company’s performance, making ordinary shares riskier but potentially more profitable.
Difference Between Preference & Ordinary Shares
The preference vs ordinary shares comparison reveals distinct characteristics that cater to different types of investors. Below are five key differences:
Dividend
- Preference Shares: Preference shares guarantee fixed dividends to shareholders, ensuring consistent returns regardless of the company’s profitability. Companies pay these dividends before distributing profits to ordinary shareholders, providing stability to preference shareholders. This feature makes preference shares attractive to investors seeking steady income with lower risk.
- Ordinary Shares: Ordinary shares, in contrast, do not offer fixed dividends. Shareholders receive variable returns based on the company’s performance and profitability. When the company performs well, ordinary shareholders can enjoy higher dividends. However, in years of low or no profit, they may not receive any dividends, making their returns more uncertain.
Voting Rights
- Preference Shares: Preference shareholders typically do not have voting rights or have very limited voting rights in company decisions. Their role is more focused on receiving fixed returns rather than participating in the governance or strategic direction of the company.
- Ordinary Shares: Ordinary shareholders hold full voting rights, allowing them to participate in key company decisions, including electing directors and approving major policies. This voting power gives ordinary shareholders a significant say in the management and future direction of the company.
Risk
- Preference Shares: Preference shares involve lower risk for investors due to their fixed dividend structure and priority in payments. Even during financial difficulties, preference shareholders receive their dividends before ordinary shareholders, reducing potential losses.
- Ordinary Shares: Ordinary shares carry higher risk since the returns depend entirely on the company’s profitability. In case of poor financial performance or losses, ordinary shareholders may not receive dividends, and their investments could decline significantly in value.
Priority in Liquidation
- Preference Shares: During liquidation, preference shareholders have priority over ordinary shareholders in receiving payments. After settling debts and obligations to creditors, the company distributes the remaining assets to preference shareholders first, ensuring better financial security for them.
- Ordinary Shares: Ordinary shareholders are the last to receive payouts during liquidation. Payments to ordinary shareholders occur only after the company has satisfied its obligations to creditors and preference shareholders. This lower priority increases their financial risk in such situations.
Convertibility
- Preference Shares: Preference shares can be issued as either convertible or non-convertible. Convertible preference shares allow investors to exchange them for ordinary shares at a predetermined rate, offering flexibility and potential for capital appreciation.
- Ordinary Shares: Ordinary shares are not convertible into other types of shares. Shareholders remain invested in the same category, with returns dependent on the company’s overall performance and profitability.
| Aspect | Preference Shares | Ordinary Shares |
| Dividend | Fixed, paid before ordinary shareholders. | Variable depends on company performance. |
| Voting Rights | Limited or no voting rights. | Full voting rights in company decisions. |
| Risk | Lower, due to fixed dividends and priority. | Higher, as returns depend on profitability. |
| Priority in Liquidation | Priority over ordinary shareholders. | Paid after creditors and preference shareholders. |
| Convertibility | It can be convertible or non-convertible. | Not convertible into other share types. |
Conclusion
The difference between preference and ordinary shares lies in their structure, benefits, and risks. Preference shares are perfect for investors seeking fixed returns and lower risk. In contrast, ordinary shares appeal to those willing to take risks for higher rewards and greater involvement in company decisions. Companies use both types to attract diverse investors and optimize their capital structure. Understanding these differences allows individuals to make informed investment decisions based on their financial goals and risk tolerance.
Preference vs Ordinary Shares FAQs
What is the main difference between preference shares and ordinary shares?
Preference shares offer fixed dividends and priority, while ordinary shares provide voting rights and residual profit claims.
Do preference shareholders have voting rights?
Generally, no, unless dividends are in arrears or specified in the share agreement.
Why are ordinary shares riskier than preference shares?
Ordinary shares have no fixed returns and depend entirely on the company’s profitability.
Can preference shares be converted into ordinary shares?
Yes, if they are convertible preference shares.
Which is better for long-term investment: preference or ordinary shares?
It depends on the investor’s goals: preference shares for stability and ordinary shares for growth potential.
