The share capital of a company can be divided into equity shares and preference shares. The distinction is not merely a label; it determines the dividend entitlement, the voting rights, the redemption obligation and the treatment on winding up.
Equity Shares
Equity shares are the residual class. The equity shareholder is entitled to dividend declared by the company, to vote on all resolutions, and to the residual assets on winding up after the preference shareholders and creditors are paid. The equity dividend is not a fixed obligation; it depends on the profits and the board’s recommendation. The equity shareholder bears the downside and participates in the upside.
Preference Shares
Preference shares carry a preferential right to dividend at a fixed rate or amount, and a preferential right to repayment of capital on winding up. The preference dividend can be cumulative (arrears accumulate) or non-cumulative. The preference shareholder’s voting right is generally limited to resolutions affecting the preference shares, and to the situation where the dividend is in arrears for the prescribed period. Section 55 governs the issue and redemption of preference shares; Section 80A governs redemption out of profits or a fresh issue.
The Redemption Mechanics
Preference shares must be redeemed within 20 years from the date of issue, unless the company is an infrastructure company or the redemption is under a notified exemption. The redemption can be out of profits available for dividend or out of the proceeds of a fresh issue of shares. A capital redemption reserve must be created where the redemption is out of profits. A company cannot redeem preference shares out of capital, and the redemption premium must be provided for in the manner prescribed.
The Choice
The choice between equity and preference depends on the investor’s return expectation and the company’s cash-flow. A preference share is suited to an investor who wants a fixed return and a priority on winding up, while an equity share is suited to an investor who wants participation in the upside and voting control. The company must ensure that the preference-share terms are within Section 55 and that the redemption is funded in accordance with Section 80A.
Call to Action: We advise companies on equity and preference share structuring, dividend rights and redemption compliance. For a share-capital review, contact office@anujdesaiassociates.com, Ph No. 9619456656, Website https://anujdesaiassociates.com, LinkedIn linkedin.com/in/ca-anuj-desai-122547230.