Difference Between Shares And Debentures
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Every business requires capital to operate and expand. It can source its capital from the company’s promoters or shareholders or through debt. When a company raises money from its owners, they are offered a right to participate in the company’s profits by way of equity shares. On the other hand, when the company borrows money by issuing securities such as debentures or bonds, it is raising money through debt. Although both are different forms of raising capital, they are very different from each other. In this article, we will highlight the difference between equity shares and debentures in detail.
What are equity shares?
Equity shares, also known as stock, represent ownership of a company. When a company raises money from the market, it is diluting its ownership. It will issue equity shares to the proportion of the money it receives. The person who holds these shares are known as equity shareholders.
Equity shareholders are entitled to receive a share in the company’s profits to the extent of shares held by them in the form of dividends. They can also participate in the company’s critical decisions, such as the appointment of a director or merger or acquisitions, through voting rights.
A company issues equity shares primarily to expand and run the business. It either issues shares privately or through a public offering, which is popularly known as an IPO or initial public offering. When a company issues shares for the first time to the public, it does so through an IPO. You can become a shareholder of a company by subscribing to the IPO or purchasing the shares from the stock exchange.
When shares are listed on the stock exchange, the price of the share fluctuates based on market demand and supply. If the demand is more, it implies people are buying more, so the price of the share rises. In contrast, if the supply is more, then people are selling the share more, so the price of the equity share falls. Hence, when you buy shares of a company, you are benefitting from the dividend and the capital appreciation.
Types of equity shares
Following are the different types of equity shares in the market.
Ordinary shares: Shares that the company first issues through an IPO are known as ordinary shares.
Bonus shares: When a company issues additional shares to the shareholders from its retained earnings, it is called a bonus issue, and the shares that are issued are known as bonus shares.
Rights shares: Shares that are only issued to premium shareholders at a discounted rate to raise additional capital to run the company are known as rights shares.
Sweat equity: When the directors or key employees receive shares at a discount in exchange for their extraordinary performance or contribution to the company, then the shares are known as sweat equity.
Employee Stock Option Plan (ESOP): Companies issue shares to employees as a retention strategy and also as a form of compensation for the work done by them. Employees who exercise their ESOP will own the shares of the company.
What are debentures?
Debentures are securities a company issues to borrow funds from the market. They are long-term debt instruments that are issued under the seal of a company. The debenture holders are creditors to the company and are entitled to interest. When the debenture expires, the company must pay back the principal amount (borrowed funds) along with the interest to the debenture holders.
Debentures are unsecured loans, so the company doesn’t provide any collateral when they issue debentures. Companies usually prefer the debenture route when they have already pledged all their assets and shares and need more money to raise capital.
Debenture holders do not carry any voting rights and, hence, do not have a say in the company’s operations. Moreover, they are not eligible to participate in the company’s profits and hence don’t receive dividends. However, they receive an interest which is paid on a regular basis or directly at the time of maturity of the debenture. If the company goes for liquidation, debenture holders have the first preference over the company’s assets and funds.
Credit rating agencies rate debentures of public companies, and hence, before buying a debenture from the stock exchange, you can check the creditworthiness of the company. A debenture with a high rating implies the risk of default is low.
Types of debentures
Secured debentures: Secured debentures are issued against collateral. In case there is a default, then the debenture holder can liquidate the asset to get back their capital.
Unsecured debentures: When debentures are issued without collateral, they are known as unsecured debentures. A company issued them using their goodwill and creditworthiness.
Redeemable debentures: Debentures which have a repayment date are known as redeemable debentures. The company must pay back the funds to debenture holders by this date.
Irredeemable debentures: Debentures which have no repayment date are known as irredeemable debentures. The company pays back the funds only upon liquidation or when they have surplus funds.
Convertible debentures: Debentures that can be converted into equity shares are known as convertible debentures. The details about the trigger date, conversion date, and rights of the holders are predetermined by the company.
Non-convertible debentures: Debentures that cannot be converted into equity shares are known as non-convertible debentures. They usually have a higher interest rate than convertible debentures.
Difference between equity shares and debentures
| Basis of Difference | Equity Shares | Debentures |
| Meaning | Represent ownership of a company and are a small part of the capital. | Represent borrowed funds of a company and are a long-term debt instrument |
| Nature of Capital | Owner’s funds | Borrowed funds |
| Status of holder | Shareholder | Creditor |
| Return | Dividends are paid out of profits | Interest is paid on a regular basis despite losses |
| Risk | High-risk investments as shareholders are owners of the company. | Low-risk investments as they are creditors to the company and receive fixed interest. |
| Tenure | Can be held for short or long-term | Debentures are long-term securities |
| Liquidity | It is very liquid and can be sold on the stock exchange at any time | It is less liquid when compared to equity shares |
| Voting rights | Have the right to participate in the company’s decisions | No right to participate in the company’s decisions |
| Profit sharing | Yes, through dividend | No, you can only receive interest |
| Repayment | Only during liquidation | Debentures usually have a maturity period |
| Conversion | Cannot be converted to debentures | Can be converted to equity shares |
| Credit rating | Not rated by credit agencies | Rated by credit agencies |
| Claim on Assets | Have the last priority after creditors and preference shareholders | Have the first claim on assets |
| Trust deed | No trust deed is required when a company issues shares | A trust deed is required when a company issues debentures |
Which is better: Equity Shares or Debentures?
Equity shares and debentures are two ends to the same string. Both help a company raise capital to run and expand its business. However, they are different in the way they operate. Equity shares give ownership to the investor and share profit in the form of dividends. Debentures, on the other hand, pay regular interest and treat investors as creditors. Both the instruments provide income in their own way.
It is up to you to decide where you want to invest your money. You have to decide based on your resources, risk tolerance level, financial goals, and tenure. If you are willing to take a risk, then equity shares have the potential to give higher returns than debentures in the long term. If you are conservative about your investments, then debentures should be preferred. In case you are unable to decide, then you can always take the help of an expert.
Frequently Asked Questions
Are debentures more risky than shares?
No, debentures are debt instruments that pay fixed interest. Moreover, in case of liquidation, they have the first claim on the company’s assets. Hence, they are less risky than equity shares.
What are the advantages of debentures over equity shares?
Debentures pay a fixed interest, and upon maturity, investors receive their principal amount back. Additionally, they have a claim on the company’s assets. In the case of equity shares, they only get dividends if the company makes a profit and decides to share it with its investors.
Which is more profitable: shares or debentures?
Shares are more profitable than debentures. This is because shareholders are not only entitled to receive dividends but also earn when the market price of the shares rises. Shareholders of high-growth companies can earn returns of more than 100% per annum.
Are debentures equity or debt capital?
Debentures are issued against the borrowed capital of the company, and hence, they fall under debt capital.
How can I buy debentures?
Debentures are listed on the stock exchange and, hence, can be directly purchased from the market.
Can debentures be converted into shares?
Yes, convertible debentures can be converted into equity shares. However, the terms of conversion, such as conversion date, rights upon conversion, and trigger date, are specified by the company.
Are debentures liabilities?
Yes, debentures are borrowed funds of a company and hence are considered as liabilities for a company.
What is similar between shares and debentures?
Shares and debentures serve the same purpose. A company raises funds from them to run and expand its business.
Are debentures better than shares?
Debentures and shares are two different ways of investing in a company. However, the way they operate is completely different. Debentures are less riskier than shares, and shares are more profitable than debentures. Hence, you must decide which one to invest in based on your resources, goals, and risk tolerance levels.
