Difference Between Shares and Debentures

Similarities between debentures vs shares

Before we discuss the disparities between the two, let us understand that both shares and debentures are similar in certain ways:

• Both are Financial Assets that can be issued to the public
• Both are lucrative sources of investment for the investor and sources of raising money for the company
• Both can be issued at discounted rates.

Meaning and Types of Shares:

Shares are a popular means of investment issued by a company, through which some of its assets are sold to the general public and thereby funds are raised. These are also known as capital, scrips, or equity. As a holder of shares, you own a portion of the company's financial capital. It gives you the right to receive some of the company's profits. The share price is the amount you pay to buy a share. In return, you are eligible for dividends determined by the company. Revenues will be announced at the end of the fiscal year. In other words, the longer you invest, the higher will be your return on shares.

Understand: What are shares

Types of Shares

• Equity Shares
• Preference Shares

The share price depends on several factors, like company performance, sector performance, market performance, and parameters related to macroeconomic. Shares have high liquidity and are traded on the stock exchange.

Explore further: Difference between Equity and Preference Shares

Meaning and Types of Debentures:

Debentures on the other hand are debt securities that are issued by a company to raise funds as a public loan. It is a confirmation from the corporation that they have taken funds from you. However, debentures cannot be treated as mortgage loans. It is only covered by the creditworthiness of the issuer but has some security. For this reason, in India, when a company files for bankruptcy, the bondholder has the first right to the company's assets.

There are different types of debentures like: 

• Perpetual Debentures have no maturity value and are treated like stocks. These bonds create a lifelong flow of income for investors and can be traded like stocks in the market.
• Convertible Debentures are offered by a few companies who offer to maintain the maturity value of bonds or convert them into stocks. This allows investors to reduce some of the risks of investing in unsecured debentures
• A non-Convertible Debenture is a traditional debenture that gives no option to convert to shares. The pay-out is offered in the form of accrued interest and maturity at the end of the term period.
• Registered Debentures and Bearer Debentures: Registered bonds are registered with the company and can be transferred by issuing a deed. Bearer bonds are not listed in the commercial register and can be transferred with simple delivery.
• Secured and Unsecured Debentures: Secured debentures are a burden for the company as they allow the investors to recover their principal amount or any unpaid interest out of the company’s mortgaged assets. Unsecured debentures don’t come with such a commitment.
• Redeemable and Non-Redeemable Debentures: The principal amount of Redeemable debentures is paid back in a fixed amount of time whereas, in non-redeemable debentures, it cannot be paid back during the lifetime of the company and only on liquidation.
• First and second Notes: First Notes are those that are repaid before other debentures whereas second debentures are those that are repaid thereafter. Notes can be either floating or fixed. When the pay-out varies with the market movement it is termed as a floating note and when the final pay-out remains assured, it can be termed as fixed-rate notes. Notes and Debentures can be used interchangeably, but they aren’t technically the same.
• Convertible and non-convertible Debentures: Convertible Debentures can be converted into shares under predetermined conditions. Non-convertible Debentures cannot be converted into shares.

Fundamental Differences Between debentures vs shares

The following are the crucial points of difference between debentures vs shares:

1. Meaning:

The shares are the owned capital of the company, whereas debentures are borrowed funds of the company.

2. Representation:

Shares represent the capital and bonds whereas debentures represent the debt and liabilities of the company

3. The Risk involved

Many investors buy company debentures because they have less market-related risk and regularly promise bonds in the form of interest payments. Equities, on the other hand, not only predict the value and growth of a company but also attract investors who are willing to take risks.

4. Interest Earned

Therefore, the return on shares is higher than the interest you receive on debentures. Interest rates remain fixed for the duration of adoption. However, shares can only be affected by market risk and can bring higher profits.

5. Terminology

People who hold shares are called Shareholders whereas people who own debentures are called debenture holders. Income from shares is called dividends, but income from debentures is called interest.

6. Allowable deduction

Dividends are used for profit and are not deducted. Interest is a business expense and is therefore acceptable as a deduction from profit.

7. Security for payment

Shares don’t have security and depend on market performance and fluctuations, but debentures come with security. These are more like unsecured loans and are given priority if the company declares bankruptcy

8. Voting Rights

Shareholders have voting rights while the debenture holders don’t.

9. Conversion

Shares can never be converted into debentures. Debentures can be converted into shares.

10. Risk and Returns

As compared to debentures, shares come with a higher risk factor and at the same a high return on investment

11. Repayment in the event of winding up

Shares are repaid after the payment of all the liabilities. Debentures get priority over shares, and so they are repaid before shares.

12. Trust Deed

No trust deed is executed in the case of shares while it is executed when debentures are issued to the public.

Conclusion

Debentures vs shares have their strengths and weaknesses. Shares give shareholders ownership and voting rights, but bonds are paid preferentially when the company is liquidated. Investment decisions should depend on your personality as an investor. As compared to debentures, Shares are considered a risky investment but offer higher returns to investors. Companies use both to raise money from the market. You can include both in your portfolio to diversify and reduce risk.