Difference Between Shares and Debentures Explained

To those new in the investment world, it becomes difficult to determine which investment instrument to invest in. Two prevalent instruments likely to be used often are shares or stocks and debentures. Although both are tools used to mobilize funds for companies, they have several similarities and differences in nature, advantages, and disadvantages. Before making an investment decision consistent with one’s financial goals and tolerance to risk, it is essential to comprehend the differences and similarities between shares and debentures. This article will focus on the difference between shares and debentures, the difference between equity shares and debentures, the difference between preference shares and debentures, and the difference between equity share and preference share and debenture.

What Are Shares?

Stocks refer to ownership rights in a firm. It is because when a person buys shares, they become an owner of the company in terms of a percentage. Shares are broadly classified into two types:

• Equity Shares (Common Shares): These are the most frequent types of shares. They are a type of security that gives the holders ownership claims in the corporation, and they can also vote to decide on issues in the company, for instance, choice of directors or approval of various corporate activities.
• Preference Shares: These have specific preferences over equity shares and are part of the company’s shares. Preference shareholders are paid a certain amount before dividends are issued to common stock shareholders. However, in most cases, they lack clauses that allow them to vote on issues concerning the company or corporation.

What Are Debentures?

Debentures are long-term funds borrowed from and secured with the public that give the borrower the right to be paid back from the profits of the enterprise or the company’s assets. When you purchase a debenture, you are lending the company money in return for a fixed amount of interest. Under debentures, investors do not have any ownership rights to the company. They are typically classified as:

• Secured Debentures: Secured debentures are those supported by some security in the company’s assets. If the company fails to repay the loan, the assets pledged as security can be sold to repay the debenture holders.
• Unsecured Debentures: Unsecured debentures, sometimes referred to as debentures, have no security behind them. Conversely, they are based on the credit strength of the firm that issues them in the market.

Key Difference Between Shares and Debentures

The difference between shares and debentures assists investors in making the right decisions. Here are the some of the main distinctions:

1. Ownership vs. Loan: Shares are used to own a part of a company, and debentures are the money borrowed by the company.
2. Returns: These are usually paid to the shareholders as a proportion of profits that can sometimes be adjusted due to the company’s profitability. Debenture holders receive a fixed amount of interest on the debenture, irrespective of the company’s profit.
3. Risk: Stocks are usually more sensitive to risk fluctuations since they imply investing in organisations with fluctuating stock exchange and performance. Debentures are generally considered safer and guarantee a fixed rate of return.
4. Control: Shareholders can vote for specific outcomes regarding the company and, therefore, have limited decision-making power. There is no provision for voting rights for the debenture holders.
5. Priority in Liquidation: Debenture holders have priority over shareholders when the company is wound up or put into liquidation.

Difference Between Equity Shares and Debentures

The difference between equity shares and debentures is significant due to their inherent characteristics.

1.  Nature of Investment: Equity share represents an ownership of the business, while debentures are an instrument of borrowing.
2. Return on Investment: Equity shareholders get dividends and capital appreciation returns, which can be significant but unpredictable. Debenture holders get guaranteed periodical interest income on the debit and thus have fixed income.
3. Risk and Security: Equity shares are more risky as their prices fluctuate according to the organizational performance and market state. Debentures are less dangerous due to fixed interest and hold priority in case of liquidation.
4. Control and Voting Rights: This is because equity shareholders are the legal owners of the business, and they have the power and the right to vote on various issues and matters relating to the industry. This means that debenture holders cannot take part in the decisions that are made in the company by having a vote like a shareholder.
5. Maturity: Equity shares have no maturity date since they are perpetual. Like other borrowing instruments, debentures also have some maturity date up to which they are issued, and after that date, the principal has to be paid.

Difference Between Preference Shares and Debentures

The difference between preference shares and debentures also highlights their distinct roles:

1. Dividend vs. Interest: Preference shares prefer a fixed dividend, while debentures, on the other hand, provide a fixed interest rate.
2. Priority in Payment: Preference shareholders are paid a fixed sum per share from the profits derived from the company’s operations, and this amount is paid before the equity shareholders but after debenture holders have been paid their interest.
3. Voting Rights: Like debenture holders, preference shareholders usually do not have any voting powers.
4. Risk and Return: Preferential shares are more risky than debentures as their dividend can be paid only at the company’s discretion. Debentures are less dangerous as they involve guaranteed interest payments at regular intervals.
5. Maturity: Preference shares can be irredeemable or redeemable at the company’s option. Debentures usually have a definite period of redemption.

A Comprehensive Difference Between Equity Share and Preference Share and Debenture

To summarise, let’s compare equity shares, preference shares, and debentures comprehensively:

1. Ownership and Control:

• Equity Shares: Hold or represent ownership, which entails voting privileges.
• Preference Shares: Dividend priority, no rights to vote or participate in company management.
• Debentures: Much like representing a loan, there are no voting rights or ownership within a company.

2. Income and Returns:

• Equity Shares: Dividends fluctuate depending on the company’s earnings.
• Preference Shares: Dividend payable of a fixed amount before equity shareholders.
• Debentures: Scheduled interest payments, regardless of organisational operations and achievements.

3. Risk:

• Equity Shares: are high risk based on fluctuating market and company performance.
• Preference Shares: Moderate risk with fixed dividends.
• Debentures: Low risk with fixed interest payments.

4. Repayment and Maturity:

• Equity Shares: Unspecified date of maturity, infinity in nature.
• Preference Shares: These can be either redeemable or perpetual.
• Debentures: Have a fixed maturity period at the end of which the principal is repaid.

5. Priority in Liquidation:

• Equity Shares: It is paid last after all remaining debts have been cleared and preference shareholders have been paid their dues. Preference Shares: Preference over equity shares but after debentures. Debentures: It has the highest status of preference as it is paid before the shareholders in the event of liquidation.

Practical Implications for Investors

Investors should choose between shares and debentures based on their risk tolerance, investment goals, and income requirements: Risk-Averse Investors Debentures should be preferred for a stable and predictable income because of the fixed interest receivables and low risk. Moderate Risk Takers May opt for preference shares for fixed returns with moderate risk and have preference over equity shares in terms of dividends. High-Risk Takers Those looking for potentially high returns and having a risk-taking ability may go for equity shares, which provide both dividend and capital gains.

Conclusion Thus, it is crucial to note the difference between shares and debentures, difference between equity shares and debentures, the difference between preference shares and debentures, and the difference between equity shares and preference share and debenture. Every financial instrument provides advantages and disadvantages that make it appropriate for a specific investment plan and goal. Understanding these differences helps the investor to manage portfolios in the financial markets and create a diverse and balanced financial portfolio. SMC Global Securities offers a comprehensive platform for investors of all experience levels. With a wide range of investment options, including shares, debentures, and mutual funds, SMC Global Securities can help you build a diversified portfolio that aligns with your financial goals. Our team of experienced professionals can provide personalised investment advice and guidance to help you make informed decisions. Also Read : Types of Debentures Author: All Content is verified by SMC Global Securities. Reference:  https://m.economictimes.com/