Shares and debentures are instruments to raise capital for a company’s expansion and growth. Shares are a portion of the company itself, whilst debentures are borrowed capital. In this article, we will understand the difference between shares and debentures.
What are Shares?
The smallest division of a company’s capital is known as shares. Shares are sold in the stock market to raise funds for the company, and the rate they are offered is known as share price. It represents the portion of ownership of the shareholder in the enterprise, and shareholders are entitled to the dividend declared by the organisation on the shares. The shares are movable or transferable.
Types of Shares
1. Equity shares
Shares traded on the stock exchange are called equity shares or ordinary shares. The owners of these shares are entitled to dividends and have voting rights. These shares are the most common to be traded.
2. Preference shares
Preference shares give importance to the shareholders and allow them to look at the enterprise’s dividends before equity shareholders. Whilst the dividend amount is predetermined, these shares do not give the shareholders voting rights.
Preference shareholders take preference over equity shareholders in an organisation’s liquidation.
How Can You Buy Preference Shares?
Preference shares can be bought through exchanges and private placement.
If you are buying through private placement, the minimum investment amount is Rs. 10 lac. If you purchase through the exchanges, the minimum amount goes as low as Rs. 10.
What are Debentures?
Debentures are long-term debt instruments issued by the company under its seal. Here, the fund is borrowed capital, similar to a debt that a company takes from debenture holders and promises to repay with interest when the time comes.
Debenture holders get paid in the form of interest at regular payments. In effect, debenture holders are lending money to the firm. The interest payments are made over and above the firm’s profit; therefore, they will not be held back if the organisation loses money.
Since debenture holders are the firm’s creditors, they have a much higher standing than shareholders. If the company has to file for bankruptcy, the firm’s creditors, like the debenture holders and banks, will be paid first. Unlike shareholders, debenture holders do not have voting rights.
Investors can quickly complete the purchase of debentures within minutes on the Yubi Invest platform. The platform provides trade and investment across different types of debentures, including non-convertible debentures and market-linked debentures.
Types of Debentures
1. Registered and bearer debentures
A registered debenture is registered with the company and can be transferred through a transfer document. On the other hand, a bearer debenture does not have a record in the company books and is transferred only by delivery.
2. Secured and unsecured debentures
A secured debenture is backed up by collateral, and the lender receives a kind of insurance against the loan not being paid back. If the borrower cannot repay the loan, the lender can redeem what is owed by acquiring the mortgaged assets. Unsecured debentures do not have such a right or fee.
3. Redeemable and non-redeemable debentures
A redeemable debenture is a written agreement about repaying a loan by a set time. The debentures can be redeemed on the expiry of the debenture issue. On the other hand, non-redeemable debentures cannot be paid back in the organisation’s lifetime. The debentures are paid only on liquidation.
- First and second debentures
First debentures are repaid before other debentures, and second debentures are repaid after that.
- Convertible and non-convertible debentures
Under predetermined conditions and terms, convertible debentures can be exchanged into shares. Non-convertible debentures cannot be converted into shares.
Key Differences Between Shares and Debentures
|Shares are small portions of the firm’s capital and the investors are called shareholders.||Debentures are long-term debt instruments that an organisation issues under its seal. The investors are called debenture holders.|
|It is a form of owned capital.||It is a form of borrowed capital, representing the borrowed funds or debt of the company.|
|The returns are in the form of dividends from the company's profits.||The returns are in the form of interest, and the company doesn't need to be in profit. Interest might be floating or fixed.|
|When going public to the investors, the issue of shares is compulsory.||When going public to the investors, the issue of debentures is optional.|
|Shares provide an entitlement toward the dividend rights to their owner.||Debentures provide an entitlement toward the interest payment component.|
|Shareholders are part owners of the company.||Debenture holders are paid off first, and they are the company creditors.|
|In case of liquidation, shareholders come last on the priority list.||In case of liquidation, debenture holders are paid off first.|
|Shareholders have voting rights.||Debenture holders do not have voting rights.|
|Shares cannot be converted into debentures.||Debentures can be converted into shares.|
|The shareholder’s funds are found on the balance sheet.||Debentures are listed in the non-current liabilities section.|
|Investing in shares is risky for investors.||For investors, investing in debentures carries less risk. It is possibly the most secure instrument.|
|Dividends on shares are not a business expense and, therefore, not allowed as a deduction.||Interest on debentures is an expense and allowed as a deduction.|
|Shares are issued at a discount, subject to some legal compliance.||Debentures can be issued at a discount without any legal compliance.|
Shares Vs Debentures
Who Are the Target Investors for Shares and Debentures?
Shares and debentures are distinct types of instruments issued by an enterprise. The target investors for each category are based on the expectations of the invetors and their essential characteristics.
Shares are a highly risky investment option. It is ideal for investors with a high-risk appetite.
Debentures are the most secure instrument and perfect for investors with a lower-risk appetite and seeking a fixed income option.
What Are the Similarities Between Shares and Debentures?
Whilst there are disparities between shares and debentures, they are also similar in specific ways.
- Shares and debentures are both financial assets that can be issued to the public by a company.
- Both are issued to the general public to generate funds for the company.
- Shareholders and debentures can be issued at a premium or a discount, depending on the company’s market capitalisation or value.
- Both are lucrative sources of investment for investors.
Shares and debentures are an important part of every organisation and common instruments to help a company raise capital. The investment decision between debentures and shares depend on several factors, such as returns expectations and risk profile of the investors and their investment
Why is debenture better than share?
Debentures are better than shares because they are a less risky investment instrument. They are fixed-income investments, and debenture holders receive interest payment at fixed intervals. In the case of company liquidation, a debenture holder is paid first, and the amount is transferred to their bank account number. On the other hand, shareholders are last on the priority list when the company faces liquidation.
What are the critical features of debentures?
The key features of debentures include:
- A debenture is a debt instrument related to a firm’s indebtedness.
- Similar to shares, debentures have a nominal value.
- They are documents issued under the seal of the organisation.
- On the back of the document, the principal repayment and terms of the issue are mentioned to help investors with their market research.
Can a person invest in shares and debentures of a company?
Yes, a person can invest in debentures and shares of a company without restrictions.
What is the process for issuing debentures and shares?
Issuing debentures and shares generally involve filing a registration statement with SEBI. The statement must provide detailed information about the firm and the securities offered. Then, the SEBI reviews the registration statement to ensure it complies with all the applicable regulations and laws. After doing so, the SEBI declares the registration statement “effective”, and then the company can offer and sell securities to the public.
Are debentures liabilities?
Debentures represent debts that the firm needs to pay in the future and are considered liabilities. In the balance sheet, debentures are shown as long-term liabilities or current liabilities.
What are the returns from investment on shares?
The returns from investment on shares are in the form of capital gains and dividends.
What are the returns from investment on debentures?
Debentures are considered one of the most secure investment instruments, and the return on investment on debenture is called interest.
What is meant by the transmission of shares?
If a shareholder becomes insolvent or expires, the property or title of the share is transferred to their legal successor. Therefore, the transmission of shares is the process of transferring shares to a legal successor by law.
Is the benefit of indexation allowed on LTCG on equity shares?
No, the benefit of indexation is not allowed on LTCG on equity shares. LTCG is taxed at the flat rate of ten per cent without indexation benefit.