Shares and debentures both are ways to raise capital however debentures are borrowed capital whereas shares are a portion of the company’s capital itself. Covered ahead are their key differences between shares and debentures for your understanding.
Shares are small divisions of a company’s capital. When a company goes public for the first time and gets listed on the stock exchanges to raise capital from the market, investors buy a share or number of shares in the company.
Purchasing the shares gives shareholders entitlement to the ownership of the company. In other words, you become owners of the company in proportion to the percentage of shares you own. Shareholding of 50% or more makes the shareholders the biggest owners of the company whereas other shareholders get an entitlement to the ownership.
As shareholders of the company, you are entitled to dividend payouts given in a certain regular fashion. The dividend payouts can come only if the company is recording profits. Otherwise, shareholders can participate in trading in the stock market to get some value out of their investment.
Shareholders are part owners of the company. They got voting rights in the company, a share of the profits in the form of dividends however being the owners in the company they do stand to lose if the company is in debt or has to go for liquidation as the owners of the company, no matter their contribution is paid out last.
Types of shares
There are primarily three types of shares that a company issues:
- Equity shares: Equity shares are the shares that are traded on the stock exchange. They are also called ordinary shares. The owners of these shares have voting rights, entitled to dividends, and are the most common type of shares that are traded.
- Preference shares: Preference shares are shares that give ‘preference’ to its shareholders to the dividends of the company ahead of equity shareholders. The amount of dividend is fixed however these shares do not carry voting rights like equity shares. Preference shareholders get priority over equity shareholders in the event of company liquidation as well. There are also convertible preference shares that can be converted into equity shares at a later date.
However, these limitations are applied only on preference shares issued by public companies or private companies which have a public subsidiary. A private company through its articles of association can issue preference shares with similar voting rights as well.
How can you buy preference shares?
If you are buying preference shares through private placement then the minimum investment amount is Rs 10 lakh. However, if you are buying them from the exchanges, the minimum amount can go as low as Rs 10 as well. Securities and Exchange Board of India (Sebi) allowed the trading of preference shares on stock exchanges in 2013.
Debentures are long term debt instruments that a company issues under its seal. One difference between share and debentures is that debentures become borrowed capital for the company. It is like a loan that a company has taken from the debenture holders which is supposed to pay back with interest in due time.
If you have invested in the company’s long term debt instruments and in effect lending money to the company, you get paid in the form of interest in regular intervals. The interest payments come over and above the company’s profit so they won’t get held back if the company is running in losses.
Debenture holders are creditors to the company. The money invested by debenture holders is basically borrowed capital for the company that it has to pay back with regular interest. This makes debenture holders creditors to the company and at a higher status than shareholders.
This means that if the company runs into major debts and is going under liquidations, the creditors of the company including banks, debenture holders, and others will be paid off first. Shareholders are given the last priority. However, unlike shareholders, debenture holders do not get voting rights. This is a major feature that can help you distinguish between shares and debentures.
Types of debentures
Following are the type of debentures in India:
- Registered and bearer debentures: A registered debenture is registered in the company and can be transferred by the issuance of a transfer deed. Bearer debentures, on the other hand, have no record of them in the company registers and can be transferred by mere delivery.
- Secured and unsecured debentures: Secured debentures have a charge on the company’s assets. So secured debenture holders can recover their principal amount or any unpaid interest out of the company’s mortgaged assets. Unsecured debentures have no such charge or rights.
- Redeemable and non-redeemable debentures: Redeemable debentures’ principal amount is paid back in a fixed amount of time whereas non-redeemable debentures cannot be paid back in the lifetime of the company and only on liquidation.
- First and second debentures: First debentures are those that are repaid before other debentures whereas second debentures are those that are repaid thereafter.
- Convertible and non-convertible debentures: Convertible debentures are those that can be converted into shares according to pre-decided terms and conditions. Non-convertible debentures cannot be converted into shares.
Here is a table the summarises how shares and debentures differ on various parameters
|1.||Meaning||Small portions of a company’s capital||Long term debt instruments that a company issues in under its seal|
|2.||Nature of capital for the company||Owned capital||Borrowed capital|
|3.||Returns||Returns come in the form of dividends only out of profits||Returns are in the form of interest and the company need not be in profits. Interest may be fixed or floating.|
|4.||Investors||Shareholders are part owners of the company||Debenture holders are creditors to the company|
|5.||In case of liquidation||Shareholders are given last priority||Creditors(debenture holders) are paid off first|
|7.||Convertibility||Shares cannot be converted into debentures||Debentures can be converted into shares|
Shares and debentures are very different in their structure and characteristics. If you distinguish between shares and debentures, both are superior in their own ways. While shares give you a share in the profits, debentures give you priority in the case the company is getting wound up. Both are ways to be invested in a company are at two fags ends of a curve. Understand your own personal investment profile and choose what suits you best.