Difference Between Shares and Debentures

Shares and debentures are financial instruments that offer different privileges to their holders. While shares are riskier in comparison with debentures, they lack conversion ability that debentures have.

In this article, we will learn about the difference between shares and debentures along with the details of these two financial instruments.

Table of Contents

• Difference Between Shares and Debentures
• What are shares?
• Types of shares
• What are debentures?
• Types of debentures
• Which is a better investment choice between shares and debentures?

Difference Between Shares and Debentures

Let us now discuss the difference between shares and debentures in terms of the following parameters:

What are Shares?

Shares represent a unit of equity ownership in a company. Shareholders get a part of the profit that the company earns in the form of dividends. Likewise, shareholders have to bear the losses that the company faces. They help the company raise capital through the stock market. Either the company goes public or issues IPO for the public. The buyers enjoy voting rights, debentures, and other benefits as per the memorandum.

How do shares work?

The company sells its shares in the market to raise capital for business. At first, when the company goes public, it issues IPO to offer its shares in the primary market for the first time to the public. These are then traded in the secondary market where investors trade among them. 

To trade shares in the secondary market, investors usually take the help of brokers to buy and sell their shares. Traders have to pay a brokerage fee to the brokers for trading. Nowadays, there are applications that are now eliminating the need for brokers to trade in the market. This saves brokerage fee that was earlier to be paid for every trade.

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Types of Shares

Following are the two main types of shares that are available: 

1. Equity shares: Also known as ordinary shares, these comprise bulk shares that are issued by a company. These are actively traded by investors in the stock market and are transferable in nature. In these shares, shareholders get voting and dividend rights.
2. Preference shares: The shareholders get preference when the company is sharing its profit. First, preferential shareholders get shares and then ordinary shareholders get the share. Even during liquidation, these shareholders are paid first. 

What are Debentures?

Debentures are debt instruments that do not have any collateral backing, which makes them unsecured. These have a term of more than 10 years. Since there is no collateral backing, these debt instruments rely on the reputation of issuers. They pay periodic interest payments that are called coupon payments. Like other types of bonds, they are documented in an indenture, which is a legal and binding contract between bond issuers and bondholders.

The contract specifies features of a debt offering including maturity date, interest timing, method of calculation, and coupon payments. Both government bodies and corporations issue debentures to raise capital or funds. However, the debentures issued by government bodies are considered low-risk investments due to the reputation of issuers. The debentures issued by corporations are considered unsecured.

How do debentures work?

While issuing a debenture, a trust indenture is drafted. These bonds pay an interest rate and are repayable at a fixed rate. The coupon rate is then determined that the company agrees to pay the debenture holders and investors. A company’s and debenture’s credit ratings play a role in impacting the interest rate that investors will be receiving. The coupon rate can either be fixed or floating. On the maturity date, the company must pay back its debenture holders. The repayment form can be decided by the company. The issuer makes these scheduled debt interest payments before they pay the stock dividends to its shareholders. 

Types of Debentures

The following are different types of Debentures available:

• Secured debentures: These debentures create a charge on the company’s assets, thus mortgaging the assets of the company. Such bonds have collateral backing which provides insurance in case the loan is not repaid. 
• Unsecured debentures: These are agreements that outline the terms and conditions of loans. There is no specific asset used as security due to which interest rates are often higher.
• Registered debentures: These include every detail of the debenture holders including names, addresses, and particular of holdings that are filed in the register kept by the enterprise. 
• Bearer debentures: These can be transferred by way of delivery of which the company does not keep any record of its holders. Anyone who produces the interest coupon attached to such debentures is paid by the company.
• Convertible debentures: These are long-term debt issued by the company that can be converted into shares of equity stocks after a specific period of time. 
• Non-convertible debentures: These are debt instruments that are used by the company when it needs to raise money from the public. A debt paper for a specific tenor is issued during which the company pays a fixed rate of interest to the buyer. 

Which is a Better Investment Choice Between Shares and Debentures?

Choosing between shares and debentures for investment depends on what you are looking for. Is it more money over time or a steady income with less risk? Here is how they compare:

Shares:

• Ownership in a Company: When you buy shares, you own a part of the company.
• Potential for High Returns: If the company does well, the value of your shares can go up a lot, meaning you could make more money when you sell them.
• Risks: If the company does not do well, the value of your shares can go down, and you might lose money.
• Dividends: Some companies pay you a part of their profits regularly, but it's not guaranteed.

Debentures:

• Loan to a Company: Buying debentures means you're lending money to the company.
• Fixed Income: Companies pay you interest on the money you've lent them at regular intervals, which is usually stable and predictable.
• Lower Risk: Debentures are generally safer than shares because you're more likely to get your interest payments and your loaned money back.
• No Ownership: You do not own part of the company, and you don't benefit if the company grows significantly.

Which is a Better Investment Choice Between Shares and Debentures?

• If you're okay with taking risks for the chance of making more money and are interested in possibly owning a part of a company, shares might be better for you.
• If you prefer getting regular payments and want to avoid big risks, debentures could be a better choice.

Conclusion

Hope this article has been helpful in explaining the difference between shares and debentures. Both financial instruments have their own benefits and return on investment. Based on your investment needs, risk tolerance, and future planning, you should choose between shares and debentures.