Issue of Shares: Equity Shares vs Preference Shares for Raising Long-term Capital

When a company needs money to grow, build a new warehouse, or expand into new markets, it has two broad routes: borrow it or raise it from owners. The second route, called equity financing, happens through the issue of shares. But not all shares are the same. A company can issue equity shares that hand over ownership and control, or preference shares that promise a fixed return without giving away the steering wheel. Choosing between the two shapes a company’s risk, its control structure, and its ability to reward owners for years to come. This is the heart of how businesses raise long-term capital.

What the issue of shares actually means 🔗

A share is a unit of ownership in a company, and issuing shares is the process of offering these units to investors in exchange for capital. Under Section 43 of the Companies Act, 2013, a company limited by shares can have only two kinds of share capital: equity share capital and preference share capital. Every other label you hear, from “ordinary shares” to “redeemable preference shares”, falls under one of these two umbrellas.

The money raised through shares is called owner’s funds or ownership capital, because the people who buy shares become part-owners of the business. This is fundamentally different from borrowing, where lenders have no ownership stake. Since shares represent long-term, often permanent capital, they are one of the most important tools a company has for financing big, slow-burning plans rather than short-term needs.

Equity shares: the company’s risk capital 🔗

Equity shares, also called ordinary shares, represent genuine ownership. The people who hold them are the real owners of the business. They carry voting rights, which means equity shareholders elect the board of directors and have a say in major decisions. They also get a share of profits in the form of dividends, but that dividend is never fixed. It rises and falls with the company’s performance.

This is why equity shares are described as risk capital. Equity shareholders are the last in line. During winding up, they are paid only after all creditors and preference shareholders have been settled. They bear the heaviest risk, but they also enjoy the biggest reward when the business does well, because the value of their shares can rise in the market.

Why companies love equity shares 🔗

Equity shares carry three big advantages for the company raising the money.

No fixed dividend burden. The company is not legally bound to pay a dividend on equity shares. If profits are thin in a tough year, it can simply skip the dividend without breaking any promise. This breathing room is precious for businesses with uncertain or seasonal earnings.

Permanent funds that need not be repaid. Equity shares are non-redeemable, so the capital stays with the company throughout its life. It is returned only at winding up, which makes equity an ideal source of long-term finance. There is no maturity date hanging over the management’s head and no scheduled repayment that drains cash flow.

No charge on assets. When a company borrows, lenders often demand security, meaning the company has to mortgage its assets. Equity shares require nothing of the sort. The company keeps its assets free and unencumbered, which leaves room to raise secured loans later when needed.

The hidden cost of too much equity 🔗

Equity is not free of drawbacks, and over-relying on it creates two problems.

The first is dilution of control. Every new equity share comes with a vote. As a company issues more and more equity, ownership spreads thinner and the original promoters can lose their grip on decision-making. A founder who once controlled the company comfortably may find their voting power shrinking with each fresh issue, raising the risk of losing managerial control altogether.

The second problem is that an all-equity structure prevents the company from taking advantage of trading on equity. This concept deserves its own section, because it is one of the most powerful reasons companies deliberately limit how much equity they issue.

Trading on equity and why share structure matters 🔗

Trading on equity, also known as financial leverage, is a strategy where a company uses borrowed funds or fixed-cost capital to boost the returns earned by its equity shareholders. The logic is simple. If a company can earn more on the money it raises than the fixed cost it pays for that money, the surplus flows straight to the equity owners.

Imagine a company that borrows at 10% interest and invests that money in a project earning 18%. The extra 8% does not go to the lenders, because their return is capped at the fixed 10%. It belongs to the equity shareholders. The same effect works with fixed-dividend preference shares. As long as the company earns more than the fixed return it owes, equity shareholders pocket the difference.

Here lies the catch with issuing too much equity. If a company funds itself entirely through equity shares, there is no fixed-cost capital in the mix, so there is nothing to leverage. Every rupee of profit is simply divided among a large pool of owners, and the per-share return stays modest. By keeping some capital in the form of debt or preference shares, a company can amplify earnings per share for its equity holders.

Of course, leverage cuts both ways. If the company earns less than the fixed cost it owes, the loss is magnified and equity shareholders suffer. Trading on equity rewards confident, profitable businesses and punishes struggling ones, which is exactly why the balance between share types has to be chosen with care.

Preference shares: fixed returns without surrendering control 🔗

Preference shares sit between debt and equity. As defined under Section 43 of the Companies Act, 2013, they carry two preferential rights that equity shares do not. First, they receive a dividend at a fixed rate before any dividend is paid to equity shareholders. Second, on winding up, their capital is repaid before equity shareholders get anything. Both rights must exist together for a share to qualify as a preference share.

The features that make them attractive to companies 🔗

Fixed dividend, paid only out of profits. Preference shareholders earn a predetermined dividend, but only when the company has profits to distribute. This gives the company more comfort than a loan, where interest must be paid regardless of how the business is doing. The dividend is a preferential claim, not an unconditional debt obligation.

No threat to promoters. Preference shares usually carry no voting rights on ordinary matters. This is a major reason companies issue them. They can raise large sums of capital without diluting control or putting the founders’ position at risk. The promoters keep their grip on decision-making while still bringing in fresh funds. There is a limited exception: under Section 47(2), if dividends remain unpaid for two years or more, preference shareholders gain voting rights, which acts as a safeguard for their interests.

Help with trading on equity. Because the dividend is fixed, preference shares act as fixed-cost capital. As discussed earlier, this lets the company leverage its capital structure and lift returns for equity shareholders when the business is profitable.

Redeemable preference shares and flexibility 🔗

One of the most useful features is redemption. A redeemable preference share can be bought back by the company after a set period. In India, the law actually requires preference shares to be redeemable, and they must be redeemed within twenty years of issue, with limited exceptions for infrastructure projects. Irredeemable preference shares are not permitted.

This redeemability gives a company real flexibility. It can raise capital when it needs it and return that capital later when it has surplus funds, without keeping the obligation on its books forever. The redemption is governed by Section 55 of the Companies Act and is subject to safeguards, such as redeeming out of profits or the proceeds of a fresh issue, so that the interests of creditors are protected.

Where preference shares fall short 🔗

Preference shares are not perfect, and some investors are wary of them. The fixed return that looks like a strength can also be a weakness from the investor’s point of view. Because the dividend is capped, preference shareholders do not benefit when the company performs exceptionally well. Equity shareholders, by contrast, can watch the market price of their shares climb and enjoy unlimited upside.

There is also the risk of non-payment. The fixed dividend is paid only if profits exist. In a loss-making year, preference shareholders may receive nothing, just like equity holders, yet they had accepted a capped return in the first place. For an investor who wanted both safety and growth, this combination can feel like the worst of both worlds. This is why preference shares appeal mainly to conservative investors seeking steady income rather than those chasing capital appreciation.

Choosing the right mix for long-term capital 🔗

The decision is rarely “equity or preference” in isolation. Most well-run companies use a thoughtful blend. Equity provides permanent, low-pressure capital and forms the foundation of the company’s risk-bearing base. Preference shares add fixed-cost capital that enables trading on equity and brings in funds without disturbing control. Layered on top of borrowed funds, this mix lets a company balance risk, control, and return.

A company expecting steady, strong profits may lean more on fixed-cost capital to amplify returns for its owners. A company in a volatile industry may prefer the safety of equity, since it carries no fixed payment burden. The art of capital structuring lies in reading the business’s prospects and matching the share structure to them.

What do you think? If you were advising a fast-growing company that wants to expand without losing founder control, how much would you rely on preference shares versus equity? And do you think the fixed return on preference shares is a fair trade for the safety they offer, or would you rather bear the risk of equity for a shot at higher gains?

References

1. https://taxguru.in/company-law/note-preference-shares-companies-act-2013.html
2. https://cleartax.in/s/difference-between-equity-share-and-preference-share
3. https://groww.in/p/trading-on-equity
4. https://www.bajajfinserv.in/what-is-trading-on-equity
5. https://www.registerkaro.in/post/section-43-of-companies-act-2013
6. https://lawgnan.in/ou-llb-3rd-sem-company-law/preference-share-capital/
7. https://www.indiafilings.com/learn/preference-shares-in-private-limited-company