Understanding the difference between shares and debentures

Introduction

In business, equity and debt are two ways for a company to raise capital. It may need funds for expansion, growth, research and development, marketing a new product, etc. When a company needs funds, it could go two ways—issuing shares to the public or through debt. There are various modes of debt, too—loans, bonds, and debentures.

In this article, we will talk about the difference between shares and debentures.

What are shares?

Shares are ownership in a company’s capital. They are the tiniest part of a company’s total capital. When you purchase a share, you own a part of the company. You could get voting rights, dividends, and other perks as part of being an owner. The price at which these shares are issued includes face value and premium, if any. You could also profit by selling your shares in stock exchanges at a price higher than what you bought for.

Shares can be categorised into two types:

• Equity shares: Equity shares can be thought of as primary shares or capital of a company. They carry voting rights and the perks of receiving dividends. A company can issue these shares to pubic as well through IPO.
• Preference shares: Preference shares can be considered second-tier shares in a company. They do not carry voting rights, but mostly the dividend paid is fixed. They are also paid before equity shareholders in the event of winding up of a company.

What are debentures?

A debenture is a debt instrument that a company uses to raise capital. When you purchase a debenture, you become a creditor to a company. You also get a fixed interest rate on debentures. The principal is repaid at maturity or when you sell the debenture in the open market. Debentures can be secured using an asset or collateral or they can be unsecured. They do not carry any voting rights because debenture holders are not owners of a company. In the event of liquidation, debenture holders are paid before preference shareholders and equity shareholders.

Debentures can be broadly categorised into:

• Secured debentures –  These are debentures that are backed with collateral
• Unsecured debentures - These are debentures that are not secured with any collateral
• Convertible debentures – These debentures can be converted into shares
• Non-convertible debentures – These debentures will not convert into shares

Similarities between shares and debentures

While shares and debentures are different types of financial instruments issued by a company, there are some similarities between the two. Both are methods of raising capital. Both shares and debentures are usually issued to the public and can be tradeable on the exchange.

Differences between shares and debentures

Apart from the aforementioned similarities, there are a lot of significant differences between shares and debentures:

• Shares represent ownership in a company, while debentures are debt instruments and don’t give you any ownership.
• If you own shares in a company, you will be a partial owner. If you buy debentures, you will be creditor to a company.
• The primary method of earning returns on shares is through dividends and appreciation in the share price. Debentures give you returns in the form of fixed interest.
• Debenture holders are paid interest irrespective of whether the company makes a profit or a loss. Shareholders are paid dividends only if the company makes a profit.
• Shareholders have voting rights while debenture holders do not.
• If a company goes into liquidation, debenture holders are paid first. This is because they are considered creditors of the company. Shareholders are paid last, with equity shareholders coming last in the line of payment.
• Shares cannot be converted into debentures. However, convertible debentures can be converted into shares.
• Shares are considered riskier than debentures due to variable returns.

Which is the better investment?

Shares and debentures are two different classes of investments. Choosing one over the other depends on your financial goals and risk appetite. Shares are high-risk investments, but they also provide the potential for high returns. Debentures, on the other hand, provide assured returns and are relatively less risky than shares. You can choose to include both in your investment portfolio for diversification.

Conclusion

Shares and debentures are essentially ways for a company to raise capital. Both can be good investment options for you as an investor. Weigh the pros and cons of both instruments before investing. You can invest in shares and debentures through any stock broker.

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