A Closer Look at the Key Differences Between Shares and Debentures

A Closer Look at the Key Differences Between Shares and Debentures

Shares and debentures are both marketable securities. However, there are many differences between the two, which you should be aware of before investing.
15 Jan, 2024 10:00am
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Companies require capital to carry out various business operations, repay their debt, pay their employees and fund business expansion and growth. There are several ways in which companies can raise the capital required for these purposes — of which the most popular ones are issuing shares and debentures. 

 

As an interested investor, you can buy shares and debentures of different companies from the primary or secondary market. However, before you do so, you need to understand the main areas of difference between shares and debentures. This will help you make informed investment decisions and plan your entry and exit into the market better. 

 

Understanding shares and debentures

Both shares and debentures are securities that companies issue to raise capital for their business requirements. However, an in-depth look at these two types of securities reveals many differences between shares and debentures. 

 

A closer look at shares

Shares represent units of ownership in a company. They can be considered as the smallest units of a company’s capital. When you buy even one share of a company, you become a part owner of that entity. Depending on the rights and benefits they offer, shares can be of two main types, as outlined below:

 

Equity shares

Equity shares are ordinary shares of a company. They are issued by companies through an Initial Public Offering (IPO) in the primary market. Once an IPO is complete, the company is listed on a stock exchange and the equity shares issued through the public offering are available to trade in the secondary market. 

 

Equity shares generally have the following key characteristics: 

  • Permanent in nature (returned only upon winding up of the company)
  • Offer dividends to shareholders 
  • Carry voting rights 
  • Carry rights to additional or surplus profits of the company
  • Highly liquid 
  • Can be traded on stock exchanges
  • Carry limited liability 
  • Give shareholders a residual claim on assets

 

Preference shares

Preference shares, as their name indicates, are shares that carry certain preferential rights. They are given priority over equity shares in many aspects, such as dividend payouts and payouts in case of the winding up of the company. The main characteristics of preference shares include the following: 

  • Can be convertible into common stock
  • Offer preferential dividend payouts to shareholders
  • Generally carry no voting rights
  • Preferential rights over the company’s assets in case of liquidation
  • Can be repurchased by the company on specific dates

 

A closer look at debentures

Debentures are debt securities that are issued by companies to the public, to gain access to borrowed funds. In simple terms, the value of debentures represents the amount of loan that a company avails of from the investors who purchase these debt securities. So, when you purchase a company’s debentures, you are essentially lending funds to the company. This is why the funds raised through debentures are termed borrowed capital. 

 

The company pays interest on this borrowed capital. So, as an investor, you can earn regular interest on your debenture investments. Since debenture holders are creditors of the company, they are also paid off first in case of liquidation, even before preference shareholders. 

 

Depending on their characteristic features, debentures can be of different types such as: 

 

  • Perpetual debentures: These debentures have no maturity value or maturity date. 
  • Convertible debentures: They can be converted into equity. 
  • Non-convertible debentures: These securities cannot be converted into equity. 
  • Secured debentures: These debentures create a charge on the issuing company’s assets. 
  • Unsecured debentures: They do not carry any charge on the assets of the issuing company.
  • Registered debentures: These are recorded in the company’s register of debenture holders.
  • Bearer debentures: These debentures are transferable by delivery alone.

 

Shares vs Debentures: The key differences

Now that you have a fair idea of what these two types of securities are, you can comprehend the shares vs debentures comparison better. Let’s take a closer look at how these two types of securities differ from one another. 

 

  • Shares are categorized as equity, whereas debentures are classified as debt instruments.
  • Shares are considered a company’s owned capital, whereas debentures are considered as its borrowed capital. 
  • A company choosing to go public is mandated to issue shares but can choose to issue debentures (or not). 
  • Shares offer returns in the form of potential capital appreciation and dividend payouts, while debentures carry the benefit of interest payouts. 
  • Shareholders are owners of the company, whereas debenture holders are creditors to the company. 
  • Some debentures can be converted into shares, but the converse is not possible. 

 

Shares vs Debentures: Comparing them at a glance

To understand the shares vs debentures comparison better, you can take a look at the table below, which summarizes the key differences between shares and debentures. 

 

Particulars

Shares

Debentures

Meaning

Units of ownership in a company

Long-term debt instruments that represent borrowed capital

Nature of securities 

Owned capital 

Borrowed capital

Risk levels

Riskier than debentures 

Less risky than shares

Nature of returns 

Dividends and/or capital appreciation

Interest income

Capacity of investors

Owners of the company

Creditors to the company

Voting rights

Voting rights available

No voting rights 

Priority in case of liquidation

Given the last priority in case of liquidation or bankruptcy, with preference shareholders being prioritized over equity shareholders 

Given first priority for payouts in case of  liquidation or bankruptcy

Convertibility 

Cannot be converted into debentures

Can be converted into shares (only if they are convertible debentures)

Credit rating

No credit ratings given

Credit ratings assigned by credit rating agencies to help investors identify the safety of these debt securities 

Liquidity

Highly liquid (particularly in the case of equity shares) 

Relativity less liquid than equity shares 

 

Conclusion 

This concludes the comparison of shares and debentures. As an investor, you’ll find that both these types of securities have their advantages. If you are looking for the potential to earn above-average returns over the long term even if it means taking on more risk, shares may be suitable for your portfolio. However, if you want a safer option that offers regular income, debentures fit the bill. Of course, you can always invest in both these types of securities too.

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