There are multiple methods through which businesses, legal entities, and governments can secure funds. As a result, different capital structures are formed based on specific needs. These structures often consist of components like share capital, reserves, and debt instruments.
Among these, shares and debentures are two of the most common tools used for raising capital or investing. Their popularity has grown significantly in recent years.
In this article, we’ll get to know the meaning of shares and debentures, explore their key features, roles, types, and highlight the main differences between them.
What are Shares?
Shares are the smallest unit into which a company’s capital is divided. They are offered in the stock market as a way for companies to raise funds, and the price at which they are sold is called the share price. Owning shares means holding a part of the company’s ownership, and shareholders have the right to receive dividends declared on those shares. Shares can also be transferred or traded between investors.
Shares are mainly classified into two types:
- Equity Shares – Also known as ordinary shares, these are actively traded on stock exchanges. Equity shareholders have voting rights in company matters. However, dividends on these shares are not guaranteed and they cannot be redeemed by the company.
- Preference Shares – These shares offer certain advantages over equity shares, especially when it comes to receiving dividends and during company liquidation. Preference shareholders are paid dividends before equity shareholders and have a higher claim on assets if the company winds up. They receive a fixed dividend but generally do not have voting rights. These shares can be acquired via stock exchanges or private placements.
Debentures
Debentures, often referred to as borrowed capital, differ from shares, which are known as owned capital. They are long-term financial instruments companies use to raise funds in the form of loans from investors. In return, the company agrees to repay the amount with interest within a set period.
Investors who purchase debentures receive regular interest payments and become creditors of the company. This gives them a higher repayment priority compared to shareholders.
If the company ever faces liquidation, debenture holders are paid before both equity and preference shareholders.
Debentures can be divided into several categories based on their features:
- Redeemable and Non-Redeemable Debentures – Redeemable debentures have a fixed maturity date, and the principal is repaid by the company within the agreed period. Non-redeemable debentures do not come with a specific repayment timeline.
- Secured and Unsecured Debentures – Secured debentures are backed by the company’s assets. If the company fails to pay, the debenture holders can claim their dues from the mortgaged assets. In contrast, unsecured debentures do not have any such backing, making them riskier for investors.
Differences Between Shares & Debentures
| Basis of Comparison | Shares | Debentures |
|---|---|---|
| Ownership Status | Represent a stake in the ownership of the company. | Considered borrowed capital; the holder is a creditor, not an owner. |
| Return Type | Investors may receive dividends, which are not fixed or guaranteed. | Investors receive fixed interest regardless of the company’s profits. |
| Voting Rights | Shareholders, especially equity holders, typically have voting rights. | Debenture holders do not get any voting rights in company decisions. |
| Repayment | Shares are not repaid during the company’s lifetime. | Debentures are repaid after a certain period or maturity date. |
| Risk Level | More risk due to market fluctuations and no guaranteed returns. | Less risky as returns are fixed and capital is returned on maturity. |
| Priority on Liquidation | Shareholders are paid after all liabilities are settled. | Debenture holders are prioritized over shareholders during liquidation. |
| Tradability | Can be freely traded in the stock market. | May or may not be listed; tradability depends on the type of debenture. |
| Capital Classification | Treated as part of the company’s equity or owned capital. | Considered as a debt or loan taken by the company. |
| Regulatory Requirements | Subject to stricter regulations from market and financial authorities. | Usually involves less regulatory complexity than issuing shares. |
| Convertibility | Cannot be converted into debentures. | Some debentures are convertible into equity shares under certain terms. |
Ideal Investors for Shares and Debentures
Shares and debentures serve different purposes and appeal to different types of investors, depending on their risk tolerance and financial goals.
Shares are better suited for individuals who are comfortable taking financial risks in exchange for the potential of higher returns. These investors are typically more experienced or have a strong appetite for market volatility.
Debentures, on the other hand, are more appropriate for those who prefer safety and stability. They are ideal for conservative investors who seek regular interest income with lower exposure to risk.
Common Features of Shares and Debentures
Though shares and debentures serve different purposes, they also share several similarities.
- Both are financial instruments that companies use to raise capital from the public.
- They can be offered to investors at either a discount or premium, depending on the company’s financial position and market standing.
- Shares and debentures are considered investment opportunities and can provide returns to investors.
- Both contribute to funding a company’s operations, helping businesses grow and expand.
