Preference capital and equity capital are two types of capital used by companies to finance their operations and investments. While they both represent ownership in a company, they have distinct characteristics and implications for investors.
1. Preference Capital: Preference capital, also known as preferred stock or preference shares, represents ownership in a company that provides certain preferential rights and privileges to the shareholders. Some key features of preference capital include:
a. Fixed Dividend: Preference shareholders are entitled to receive a fixed dividend before any dividend is paid to equity shareholders. The dividend rate is typically specified as a percentage of the face value of the preference shares.
b. Priority in Asset Distribution: In the event of liquidation or winding up of the company, preference shareholders have a higher claim on the company's assets compared to equity shareholders. They have priority in receiving their investment back before equity shareholders receive anything.
c. Limited Voting Rights: Preference shareholders often have limited or no voting rights. They may not have a say in the company's management or decision-making processes.
d. Non-Participation in Profits: While preference shareholders receive a fixed dividend, they generally do not participate in the company's profits beyond the predetermined dividend rate. They do not benefit from the company's growth or receive additional dividends if the company performs exceptionally well.
Preference capital is considered a hybrid form of financing, lying between debt and equity. It provides investors with a fixed income stream and higher priority in asset distribution compared to equity shareholders.
2. Equity Capital: Equity capital represents ownership in a company in the form of common shares or ordinary shares. Equity shareholders are the residual owners of the company and have certain rights and privileges, including:
a. Dividend Participation: Equity shareholders participate in the profits of the company through dividends. After preference shareholders receive their fixed dividend, the remaining profits can be distributed among equity shareholders as dividends, subject to the company's earnings and dividend policy.
b. Voting Rights: Equity shareholders generally have voting rights, allowing them to participate in the decision-making processes of the company. The number of votes typically corresponds to the number of shares owned.
c. Residual Claim on Assets and Profits: In case of liquidation or winding up of the company, equity shareholders have a claim on the remaining assets after all debts and obligations, including those to preference shareholders, have been settled. They also have the potential to benefit from the company's growth and increased profitability through capital appreciation.
Equity capital represents the long-term risk capital invested in a company by its owners or shareholders. It carries higher risk compared to preference capital but also offers the potential for higher returns and participation in the company's success.
In summary, preference capital provides fixed income and priority in asset distribution, while equity capital offers participation in profits, voting rights, and potential capital appreciation. Companies utilize these different types of capital to raise funds from investors based on their specific financial needs and investor preferences.
