Difference between Share and Debenture: All you need to know
There are a variety of ways in which companies, legal entities, and governments can raise capital. This means that there are distinct forms of capital structures that can be formed according to one’s suitability. It can include number components such as share capital, reserves, debt funds, etc.
Out of it, Shares and Debentures are known to be one of the most popular terms when it comes to raising capital or making investments. We have seen a huge rise in the investment of shares and debentures in recent years.
Let us understand in detail what these terms mean, their characteristics, functions, types, and most important differences.
What are Shares?
Shares are instruments that allow us to partly take ownership of a company by becoming a shareholder or stakeholders of the company. These can be simply defined as the smallest division of a company’s capital structure.
When a company decides to list itself on the stock exchange to raise capital through the help of an IPO (Initial Public Offering), or simply goes public, it allows the investors in the market to buy their issued shares and become a stakeholder of the company and enjoy various rights, benefits, and advantages under its memorandum.
It can primarily be categorized into the following:
1- Equity Shares- These are also called ordinary shares and are traded on the stock exchange. They provide its owners with voting rights while the dividend rate is not fixed and is irredeemable.
2- Preference Shares – As the name suggests, these are types of shares that provide preference rights to their owners as compared to an equity share over the dividend distribution of the company. They provide priority to its shareholders if in the future a company gets liquidated in the hierarchy of distribution of capital after the settlement of liabilities. They do have fixed dividends but do not provide voting rights to their owners. One can buy preference shares either through exchanges or private placement.
What Are Debentures?
Debentures, which are also commonly called borrowed capital, as compared to shares which are termed owned capital, are a form of financial debt instrument which are long-term in nature. Since it is a borrowed capital for a company it can be understood simply as a loan taken by the company to raise capital from investors and is to be paid back with an interest component within a specified timeline.
These interest components are usually regular and give their purchaser the title of a credit holder to the company, which outranks the status of a shareholder.
This means that if in the future the company dissolves or liquidates, the creditors of the company would be paid first and the shareholders after, including those with preference shareholdings.
Debentures can be categorized into the following:
1- Secured and unsecured Debentures – Secured debentures are those which have a charge on the company’s assets. This means that the owners of secured debentures can recover their principal amount or unpaid interests from the assets of the company which are mortgaged. Unsecured Debentures on the other hand do not provide any of the above functions.
2- Redeemable and non-redeemable debentures- Here with a redeemable debenture the principal amount of money is redeemed within a period which is pre-fixed. While non- redeemable debentures do not provide that option.
There are various other categories such as Convertible and non-convertible debentures, first and second debentures, and registered and bearer debentures.
Difference Between Shares And Debentures
1- Share or Share Capital is a company’s owned capital while a Debenture is its obligation to the debt provider or creditor.
2- When going public to the investors, the issue of shares is compulsory while the issue of debentures is optional.
3- Shares provide an entitlement towards the dividend rights to their owners while debentures provide an entitlement towards the interest payment component.
4- Debenture holders do not have any management rights like shareholders because they are a creditor to the company while shareholders are owners of the capital with voting rights.
5- Convertible debentures allow the owner to convert into shares or other forms of ownership capital while this conversion option is not with a shareholder.
6- One can find the shareholder’s fund in the balance sheet under the shareholder’s fund section. On the other hand, debentures are listed in the non-current liabilities section stated under long-term liabilities.
|Meaning||Shares are the ownership capital of the company||Debentures are borrowed funds of the company|
|Rights||Shareholders have voting rights.||Debenture holders do not have any voting rights|
|Risk associated||Shareholders are the riskiest owners of a company.||For an investor, a debenture is much less risky and possibly the most secure instrument,|
|Obligation||Shareholders are not obliged towards the assets of a company||Debenture holders do have an obligation in their favor on all assets as they are creditors|
|Returns||Shareholders get returns in dividends which come out of profit||Debenture holders are repaid with returns with interest, which can be fixed or floating even if the company has earned no profits.|
|At the time of Liquidation||Shareholders are given the last priority in the hierarchy.||Debenture holders get the priority as they are creditors of the firm.|
|Possible Deduction||Since dividend comes out of profit it is not allowed for deduction||Since interest payment is an expense for a business it is allowed as a deduction from profit.|
|Conversion||Shares are non-convertible in perpetuity.||With the help of convertible debentures, debenture holders can convert to shares or another form of ownership capital.|
The method of buying a debenture or a bond is similar to a stock or share. Since there is always an outpouring of recommendations and news on common shares, here are a few of the top trending debentures as of July 2022:
However it is advisable for an investor to do a thorough market research before making a viable investment in these bonds.
|Popular Bonds||Expense ratio||Assets Under Management|
|HDFC Corporate Bond Fund-Growth||0.6%||INR 25,998 Cr.|
|ICICI Prudential Corporate Bond Fund-Growth||0.59%||INR 17,480 Cr.|
|Aditya Birla Sun Life Corporate Bond Fund-Growth||0.46%||INR 19,695 Cr.|
|Kotak Corporate Fund Growth||0.61%||INR 11,555 Cr.|
|IDFC Corporate Bond Fund-Growth||0.6%||INR 19,500 Cr.|
Disclaimer: The securities quoted are exemplary and not recommendatory. Past performance is not indicative of future returns
So, both shares and debentures are excellent financial assets and instruments serving as an investment tool and capital raising strategy. They both differ in their functions and benefits and are out performing in their own ways. One provides a share in the profits while the other provides priority and interest income. However, it is important for a real-time investor to understand if their investment goals are in order so they can maximize their profits and leverage risk as may appear to be suitable.
Is there a premium for preference shares?
One has to pay a minimum amount of Rs 10,00,000 if they are buying preference shares through a private placement but if they are buying from an exchange, the minimum amount can be Rs 10 as well.