Shares & Debentures: What's the Difference?| Espresso

Difference Between Shares And Debentures Explained

If you are thinking of investing in a wide variety of assets, shares and debentures are amongst the most popular options you can opt for. Both shares and debentures are means for companies to raise funds from the market. However, they are extremely different in terms of their respective meanings, structures, and returns.

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Before understanding the differences between shares and debentures, let us discuss their meaning and nature.

What are Stocks?

Stocks, also referred to as shares or scrips, are pieces of a company's paid-up capital.  Companies offer their shares to the public through an Initial Public Offering or IPO. Interested investors can apply for the shares of a company through an IPO, and if they get the allotment, they become part owners of the company to the extent of the shares held by them.

The price you pay to buy a company's shares is the cost you bear for investing in said shares. As consideration, you get voting rights in the company's Annual General Meeting. You are also eligible to receive a part of the company's profit announced as a dividend.

Types of Stocks

There are two major types of shares that are offered by companies, namely equity shares and preferences shares:

1.Equity Shares: An equity share or common stock of a company entitles a stockholder to get dividend income and participate in the votings of the Annual General Meetings of the company. There are, however, no preferential rights conferred upon such shareholders.

2.Preference Shares: As its name suggests, a preference share is a type of share that confers upon the shareholder the right to get preference in the receipt of dividend and the repayment of the price of the share in the event of the company being wound up or becoming bankrupt. These shares, however, carry no voting rights. Preference shares can be in the form of cumulative, non-cumulative, and convertible preference shares.
Also Read about Cumulative Preference Shares

What are Debentures?

Debentures are instruments of debts issued by a company to raise funds. Instead of taking a loan from a bank or financial institution, companies sell debentures to take small loans from investors. The degree of security associated with a debenture depends on the creditworthiness of the company issuing it.

The price you pay to purchase a company's debentures is the cost of investment in them. As consideration, you will get a sum as interest as per the timelines and interest rate specified during the sale of the debentures. Since the interest due to debentures is a debt-surviving liability, this amount is paid out to debenture holders before any dividend is paid to the shareholders of a company.

Types of Debentures

Companies offer two types of debentures, namely convertible debentures and non-convertible debentures.

1.Convertible Debentures: Convertible debentures can be converted into shares in the future.

2.Non-convertible Debentures: Non-convertible debentures cannot be converted into shares. There are two subtypes of these types of debentures, that is, secured debentures and unsecured debentures.

Differences Between Shares and Debentures

Here are the major differences between shares and debentures.

Parameter

Shares

Debentures

Meaning

Shares are small pieces of a company's capital.

Debentures are small pieces of debt raised by a company.

Nature of Capital

The funds raised through the issue of shares is share capital or owned capital for a company.

The funds raised through the issue of debentures is borrowed capital or debt for a company.

Ownership

Shares provide their holders with a part of the ownership of a company.

Debentures do not provide their holders with any ownership of a company.

Types

There are two main types of shares, namely, equity shares and preference shares.

There are two main types of debentures, namely, convertible debentures and non-convertible debentures.

Convertibility

Shares cannot be converted into debentures.

Convertible Debentures can be converted into shares after a specific period of time.

Risk

Since there is no certainty of dividend payout for the shareholders of a company, they are considered high-risk instruments.

Debenture holders are entitled to receive the interest on their debentures as per a predetermined rate, making them low-risk instruments.

Return

Shares can provide their holders with high returns in the form of dividends.

Debentures provide their holders with low to moderate returns in the form of interest payouts.

Voting Rights

Shares confer upon their holders the right to vote in a company's Annual General Meeting.

Debentures do not confer any voting rights upon their holders.

Repayment in case of winding up of company

In the event of a company being wound up or becoming insolvent, the shareholders are last in the order of repayment, after the repayment to all creditors.

If a company gets winded up, debenture holders, being creditors of the company, are first in the order of repayment, followed by preference shareholders and equity shareholders.

Credibility

The shares of a company are purchased on the basis of the past performance and market standing of the company.

The credibility of the debentures of a company is assessed on the basis of the credit rating of the company.

To Sum It Up

Both shares and debentures have their pros and cons. It is advisable to opt for the shares and debentures of companies that have a strong position in the market as well as adequate credit rating.

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Frequently Asked Questions

Yes, there is a certainty of return for debenture holders. Since debentures are instruments of debt, the interest payable on them takes precedence in the priority list of a company. These payments are fixed expenses and must be honoured before the net profit of a company (or net loss) is computed.

Yes, the debentures of a company can be converted into its shares, provided they are convertible debentures and carry the option of said convertibility.

As an investment option, shares are neither better nor worse than debentures. The choice of investment avenue depends on your investment objective, risk profile, and expectation of return. If you are looking for a high-risk and high-return investment option, you must prefer shares over debentures. However, if you wish to invest in a low-risk and low-return investment option, debentures are more suitable for you than shares.