Difference Between Shares and Debentures

What are Shares?

What are Debentures?

What is the Difference Between Shares and Debentures?

Understanding the differences in shares and debentures allows an investor to choose based on the investor's investment objective and risk. Here's a breakdown of their key differences:

Basis of Comparison Shares Debentures
Meaning Denotes ownership interest in the company. Denotes a loan or the debt taken by the company.
Nature of Capital Equity capital (owned capital). Debt capital (borrowed capital).
Returns Holders of shares receive dividends, which depend on the company's profits. Holders of debentures receive interest payments regardless of the profits the company earns
Risk Increased risk for holders of shares due to the market fluctuating, and depending on the company's status. Less risk for holders of debentures since the interest payment is fixed and predictable.
Voting Rights Shareholders have voting rights in company decisions (for equity shares). Debenture holders do not have the right to vote.
Priority in Liquidation Holders of shares are last in line to claim any assets due to liquidation. Holders of debentures have a priority in liquidation over holders of shares.
Convertibility Shares cannot be converted into debentures. Debentures may have conditions for conversion into shares (convertible debentures).
Market Influence The price of shares fluctuates considerably depending on market conditions. The price of debentures has limited fluctuation compared to shares.
Type of Income Dividend income, subject to company profits and is not guaranteed. Interest income is fixed and guaranteed, barring company failure.
Duration The company has no fixed duration as long as it exists, unless sold by the shareholder. The company has a fixed duration until the principal repayment occurs to the debenture holder.
Ownership Rights Shareholders are partial owners of the company. Debenture holders are creditors and have no ownership status in the company.
Filing Requirements No trust deed filing is needed for shares. Debentures often require A trust deed filing to protect investors' interests.
Tax Treatment for the Company Dividends to shareholders are not tax-deductible to the company. Interest payments to debenture holders are tax-deductible to the company.

Types of Shares

Shares are units of ownership in a company, which are subdivided into different classes based on their features, rights, and benefits, determining the possibilities for ownership. Below are the key types of shares:

Basis of Classification Type of Share Description
Equity Shares Authorised Shares Authorised shares are the total number of shares a company can legally issue, as defined by its articles of incorporation or charter.
Issued Shares Issued shares are the authorised shares distributed to investors, employees, or stakeholders.
Subscribed Shares Subscribed shares are the number of authorised shares that investors have promised to purchase.
Paid-Up Shares Paid-up shares are those subscribed shares for which investors have paid the subscription price in full.
Bonus Shares Bonus shares are allocated to current shareholders at no cost to reward their investment.
Rights Shares Rights shares are offered to existing shareholders and sold at a discounted price to raise more capital.
Voting Shares Voting shares grant shareholders the right to vote on key corporate matters, such as electing the board of directors and approving major decisions.
Non-voting Shares Non-voting shares provide ownership but do not allow shareholders to participate in voting on company management or policy decisions.
Sweat Shares Sweat equity shares are issued by a company to employees or directors at a discount or for non-cash consideration, rewarding their contributions.
Preference Shares Redeemable Preference Shares Redeemable preference shares are a type of preferred share in which the company can buy the shares back after a set period.
Irredeemable Preference Shares Irredeemable preference shares are a kind of preference share that the company cannot redeem except in the event of liquidation or cessation of trade. 
Convertible Preference Shares These preference shares allow shareholders to convert them into common equity shares after a predetermined period. 
Non-convertible Preference Shares Non-convertible preference shares are shares that cannot convert into common equity shares. They provide fixed dividend payments in the event of a liquidation.
Participating Preference Shares These shares allow the holder to participate in other profits in addition to the fixed dividend rate and potentially reap greater returns than non-participating preference shares.
Non-participating Preference Shares Non-participating preference shares only provide a fixed dividend without any rights to additional profits. Such dividends are predictable and consistent.
Cumulative Preference Shares Cumulative preference shares allow the owner to carry forward each unpaid dividend. They will not receive payment before the common shareholders.
Non-cumulative Preference Shares Non-cumulative preference shares do not carry unpaid dividends forward; owners will forfeit any missed payments.

Types of Debentures

Debentures can be categorised based on security, conversion, repayment, registration, and interest rate. Here is a summary of the types of debentures:

Basis of Classification Type of Debenture Description
Security Secured Debenture These are secured by particular company assets, which protect an investor in the case of default. It can be either a fixed charge or a floating charge.
Unsecured Debenture It is not secured by any collateral and is only based on the borrower's repayment ability. These can be more risky than secured debentures.
Redeemability Redeemable Debentures Have a set maturity date. At maturity, the principal amount is paid to investors as either a lump sum or in instalments to relieve borrowers.
Irredeemable Debentures These debentures do not have a maturity date. The cash obligation remains until the company either goes bankrupt or decides to close.
Convertibility Convertible Debentures Debentures that can convert the principal debt into equity shares, usually after a defined time. This hybrid debt/equity vehicle initially has a fixed return.
Non-Convertible Debentures These do not allow its holders to convert them into equity shares. Investors in Non-Convertible Debentures receive a higher interest rate as they lack convertibility.
Registration Registered Debentures The particulars of registered debenture holders are identified on a register maintained by the company, through which interest payments are assured to owners.
Bearer Debentures The holder of a bearer debenture is the individual who possesses it. The interest payment goes to the person with the coupon attached to the bearer's debenture.
Coupon Rate Specific Coupon Rate Debentures These debentures are issued with a stated coupon rate, which earns the holder predictable, regular income.
Zero-Coupon Rate Debentures Zero-coupon rate debentures do not pay periodic interest; rather, they are issued above their face value.
Priority in Payment Preferred Debentures First mortgage debentures are secured by a charge on the company’s assets and have the highest repayment priority among debenture holders in case of liquidation.
Ordinary Debentures Second mortgage debentures are also secured, but their claim on the company's assets is subordinate to first mortgage debentures.

Similarities Between Shares and Debentures

Shares or Debentures: Which is Better?

FAQs about Shares vs Debentures

What is the primary purpose of issuing shares and debentures?

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Companies issue both shares and debentures to raise capital. Shares are equity capital for shareholders, while debentures are debt capital that must be repaid to investors.

How do shares and debentures differ regarding ownership?

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Shares represent ownership in a company. They give shareholders voting rights and a portion of profits. Debentures are loans made to a company and do not provide ownership. A debenture holder will be considered a creditor rather than an owner.

What effect do market fluctuations have on shares and debentures?

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Shares will be very sensitive to the market, and their value can be heavily impacted. There is less impact on debentures because the return is fixed and less impacted by the market.

How do shares and debentures impact a company's financial leverage?

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Shares will raise the total equity in the business, but debentures will boost the debt levels. This difference in equity financing will change the company's risk and financial leverage.

Can shares be used as collateral for loans?

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Yes, shares can be used to leverage a loan. Margin lending often involves investors borrowing money against shares, and this practice usually applies to other assets, too.

How do shares and debentures differ in liquidity?

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Due to active trading on exchanges, stock is usually more liquid than debentures. Debentures may be tradable in the secondary market, but will likely be less liquid.

What are the different types of equity shares?

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Equity shares come in various types, such as authorised, paid-up, issued, and subscribed shares. There are also bonus shares, rights shares, and growth shares.

What are the types of debentures?

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Debentures are classified based on:

  • Security: Secured or Unsecured
  • Convertible: Convertible or Non-convertible
  • Tenure: Redeemable or Irredeemable
  • Coupon Rate: Specific or Zero-coupon
  • Registration: Registered or Bearer

What impact do shares and debentures have on a company's financial statements?

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Shares appear as equity on a company's balance sheet, while debentures show up as debt. This difference affects the company's leverage ratio and other signs of its financial health.

Can debentures be secured or unsecured?

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Yes, debentures can be secured or unsecured. Secured debentures have specific company assets as collateral for lenders, giving investors extra security. Unsecured debentures lack collateral and depend only on the company's ability to pay.

What is the purpose of a trust deed in the issuance of debentures?

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A trust deed is usually needed when issuing debentures. It protects the interests of debenture holders. It outlines the rights and duties of the debenture, ensuring the company meets these responsibilities.

How do shares and debentures differ regarding maturity?

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A share does not have a definitive maturity date. It exists until the company closes, unless the shareholder sells the share. A debenture usually has a defined maturity date. After such a date, the principal is repaid to the debenture holder.

What are the implications of shares and debentures on a company's cost of capital?

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The cost of capital to a company will impact both shares and debentures. Shares usually have a higher capital cost than debentures. This is due to the potential for high returns and the greater risks that come with equity.

What is the influence of shares and debentures on investor behaviour?

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Investors usually buy shares to grow their capital. They accept more risk for the chance of higher returns. Debentures offer fixed interest payments. They attract risk-averse investors seeking stable capital and predictable returns.

Can debentures be bought and sold on the secondary market?

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Yes, debentures can be bought and sold on the secondary market, although they may not have the same liquidity as shares; debenture holders can sell in the secondary market before maturity.

How do shares and debentures affect the financial flexibility of a company?

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Shares boost financial flexibility because they are equity capital that doesn't need to be repaid. Debentures are a type of debt. They require the company to pay interest regularly and repay the principal. If not managed well, this can limit financial flexibility.

What is the difference between shares and debentures?

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Shares represent ownership in a company, giving shareholders voting rights and a claim on profits (dividends). Debentures are debt instruments giving holders fixed interest payments and priority over shareholders in case of liquidation, but do not have ownership or voting rights.

Which is Better: Shares or Debentures?

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The choice between shares and debentures depends on your risk appetite and investment goals. Shares can offer higher returns, but they carry higher risks. Debentures are generally safer, providing fixed income and capital preservation, but with lower returns.

Can debentures be converted into shares?

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Yes, certain debentures, called convertible debentures, can be converted into shares according to terms set at issuance. After conversion, the debenture holder becomes a shareholder with ownership and voting rights.

Which is more risky: shares or debentures?

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Shares are riskier due to their dependence on company performance and market volatility. Debentures are less risky, offering fixed returns and repayment priority in case of company liquidation.

Which will offer voting rights: shares or debentures?

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Only shares offer voting rights to their holders. Debenture holders do not have any voting rights in company matters.

Disclaimer

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  • This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
  • All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
  • Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.

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