What Are The Differences Between Shares And Debentures?

What Are The Differences Between Shares And Debentures?

Differences Between Shares And Debentures: Selecting the best investment options for wealth management is an area where people of all income groups are quite concerned.

While accumulating money and building wealth is critical for a financially secure future, it doesn’t make sense to be dependent on savings alone.

Instead, opting for some of the renowned investment options in India is just one way through which an investor can make his/her money grow in the long run and benefit from compounding.

More often than not, investments are seen as synonymous with the stock market or equity. Most investors tend to make their investment after considering factors like liquidity, flexibility, customized investment period, tax and other benefits, etc.

On the basis of goals and needs, an investor can decide which factor is more significant to him/her when they are investing for the long-term. Investors have to keep in mind that they cannot have the best of all worlds.

Every investment will exhibit a few strong factors, while it will compromise on other factors. Therefore, in this article, we will explain the major differences between shares and debentures.

Definition of Shares

The smallest division of the organization’s capital is referred to as shares. These shares tend to get offered for sale in the open market i.e., the stock market. The companies plan to raise capital for expansion purposes or for any other purposes.

This is the main reason that they opt to sell shares in the open market. The rate at which these shares are offered to the investors is known as share price.

This exhibits the portion of ownership of a shareholder in a particular company. Since by purchasing shares the investors become part owners of the company, they are eligible for dividend payments which might be declared by the company on the shares.

Shares are classified into 2 major categories:

  • Equity Shares: These shares carry voting rights and the dividend rate is not fixed. They are irredeemable. If the company goes into liquidation, shareholders are repaid only after the payment of all liabilities.
  • Preference Shares: Even though preference shares don’t carry voting rights, the dividend rate is fixed on such shares. They are redeemable. As the name indicates, if the company goes into liquidation, these shares are given preference over equity shares at the time of repayment.

Definition of Debentures

Debentures are defined as long-term debt instruments which are issued by the company under its common seal. Holders are known as debenture holders, showing indebtedness to the company.

The capital which has been raised is borrowed capital, and this is the main reason that the debenture holders are known as creditors of the company.

Debentures can be redeemable or irredeemable in nature. They are freely transferable. Investors can earn a return on debentures in the form of interest payments which are at a fixed rate. Most of the debentures are secured by a charge on assets.

However, companies can issue unsecured debentures also. Debentures are classified into the categories such as secured debentures, unsecured debentures, convertible debentures, non-convertible debentures (NCDs), etc.

Differences Between Shares and Debentures

Now that the definition of both asset classes has been explained, it will be much easier for an investor to understand the differences between shares and debentures.

1. Meaning

The shares mean the owned capital of the company. On the other hand, debentures mean borrowed funds of the company.

2. On the Basis of Representation

Shares mean the capital, while debentures mean the debt and liabilities of the company

3. Risks Involved

Several investors opt to buy company debentures as they have lesser market-related risk in comparison to shares and they regularly provide pay-outs in the form of interest payments.

On the contrary, investing in the equity of the company has a higher risk as prices fluctuate on a daily basis and the pay-outs are closely linked with the performance of the company.

4. Interest Earned

Since equities carry higher risk, the return on shares is much higher in comparison to the interest received on debentures.

5. Rating

In the case of equity shares, no rating is given. Investors tend to make guesses about the share performance on the basis of historical and current data that they get from different financial charts.

On the other hand, debt instruments of the companies are rated by credit-rating agencies on a scale of A to D. The companies having “AAA” ratings are the safest.

6. Voting Rights

The investment made in the equity shares of the company gives an investor voting rights in the company. On the other hand, debenture holders have no voting rights.

Hence, debenture holders don’t have management rights like shareholders. This is because they are termed as creditors to the company, while shareholders represent part ownership.

7. Option of Convertibility

Convertible debentures enable the owner to convert their debentures into shares or other forms of ownership capital. However, shareholders of the company don’t have this option.

8. At the Time of Liquidation

If the company goes bankrupt, shareholders are the ones who are paid the last as per the hierarchy. On the other hand, debenture holders are given priority as they are known creditors of the company.

Also Read: How Much Return On Investment In Debentures Can We Get?

In Closing

There are wide differences between shares and debentures, yet both these instruments are considered excellent financial assets and instruments which serve as investment tools and capital raising strategies.

Both these instruments differ in their functions and advantages and they continue to outperform in their own unique ways. While shares offer a part of the company’s profits, debentures offer priority and interest income.

Therefore, it is important for an investor to critically examine and monitor both these investment avenues according to their risk tolerance levels and their financial goals.

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