There are different ways in which a company, business, legal entity or government can raise capital for different purposes for their operations. In other words, there are distinct forms of capital structure that can be formed by any business based on their suitability. However, the most common method for raising capital is by issuing shares or debentures. Both of them have different meaning and characteristics. In this article, we will discuss in detail the difference between shares and debentures.
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A company issues shares to raise capital while diluting its ownership. This means that investors can purchase shares to get part ownership of the firm. Also, by purchasing equity shares, investors are contributing to the company’s total capital. Thus, becoming a shareholder. Therefore, the shareholders are the company owners to the proportion of equity shares held by them.
A shareholder becomes a part of the company’s profits. They receive dividends or bonuses when the company distributes its profits. In addition, shareholders also enjoy voting rights in the critical matters of the company as company owners. Moreover, the shareholders can participate in stock market trading to increase their investment value. The most common types of equity shares are ordinary shares and preference shares.
The types of Shares are listed below-
What are Debentures?
A debenture is a debt instrument that the company or government uses to raise capital by borrowing or taking a loan from the public. Also, it is a legal certificate that mentions how much the investor has invested, the interest amount the investor receives and the schedule of payments. Furthermore, it mentions the date of maturity when the principal and interest amount is to payable.
The debenture holders become the creditor of the company. The debenture holder’s money becomes the borrowed capital for the company. Also, the company must pay regular interest on this borrowed capital. However, the repayment of principal and interest payments depends solely on the creditworthiness of the issuing company. Moreover, debenture holders are given a higher stance over the shareholders. Hence, the company fixes the debt interest payments before paying stock dividends to shareholders. Also, when the company goes under liquidation, the creditors of the company are paid first, while the shareholders are given the last priority.
Types of Debentures are classified into two types –
The following are the critical difference between shares and debentures –
|Meaning||Shares are a small fraction of a company’s capital.||Debentures are long term debt instruments that companies issue to borrow capital.|
|Nature of capital||Owned capital||Borrowed capital|
|Investors||Shareholders are the company owners of the proportion of shares held by them.||Debenture holders are company creditors|
|Return||The company pays dividends to shareholders out of its profits.||The debenture holders receive interest payments even if the company makes no profit.|
|Risk||Shares are risky investments as they are affected by market volatility.||Debentures are less risky than shares. Also, If a company issues secured debentures which are backed by assets, the holders have an assurance of payment.|
|Liquidity||Shares are highly liquid securities which can be bought and also sold on the stock exchange quickly.||Debentures are less liquid in comparison to equity shares.|
|Voting rights||Shareholders have the voting rights.||Debenture holders do not have voting rights.|
|Conversion||Shares cannot be converted into debentures.||If the company issues convertible debentures, they can be converted into company shares.|
|Credit Rating||No credit rating is given.||The debentures are rated by the credit rating agencies. Companies with the highest rating are the safe.|
|Payment in case of bankruptcy||Shareholders are given the last priority for payment in case of bankruptcy.||Debenture holders are paid first when the company goes bankrupt.|
|Treatment of profit||Dividends are declared out of the company’s net profit.||Interest on debentures is an expense to the company and is also deducted to arrive at net profit.|
|Trust Deed||A trust deed is not required while issuing shares.||Since debentures are circulated to the public, a trust deed is required.|
Shares and debentures are vastly different in their structure and attributes. Both are excellent financial assets. Also these instruments serve as an investment tool for investors and capital raising for companies. Share provides a portion of a company’s profit, while debentures provide priority and interest income. Thus, both shares and debentures are ways to invest in a company and are two fag ends of a curve.
Shares are suitable for investors looking for capital appreciation in the long term but they are subject to market volatility. On the other hand, debentures are suitable for investors looking for fixed interest payments and capital protection at the end of tenure. Hence, taking expert advice on which instruments suit your requirements is advisable.