Shares and debentures are both forms of securities that companies issue to raise capital, but they represent different financial instruments with distinct characteristics. Here are five key differences between shares and debentures:
Nature:
Shares: Shares represent ownership in a company. When an individual holds shares of a company, they become a shareholder or equity holder. Shareholders have ownership rights, including voting rights and the right to share in the company’s profits through dividends.
Debentures: Debentures, on the other hand, represent a form of debt. When an individual holds debentures, they are essentially lending money to the company that issued the debenture. Debenture holders are creditors of the company and have a fixed claim on the company’s assets.
Ownership and Control:
Shares: Shareholders are part-owners of the company, and they may have voting rights in certain matters related to the company’s management and policies. The number of votes is typically proportional to the number of shares held.
Debentures: Debenture holders do not have ownership rights or voting privileges. They are creditors of the company and have a contractual relationship with the issuer, but they do not participate in the company’s management decisions.
Returns:
Shares: Shareholders earn returns in the form of dividends and capital gains. Dividends are a share of the company’s profits distributed to shareholders, and capital gains result from the increase in the value of the shares over time.
Debentures: Debenture holders earn returns in the form of periodic interest payments. The interest rate is fixed, and it represents the cost of borrowing for the company. Unlike shareholders, debenture holders do not participate in the company’s profits beyond the agreed-upon interest rate.
Risk and Reward:
Shares: Shareholders bear the risk of the company’s performance. If the company does well, shareholders may benefit from higher dividends and capital appreciation. However, if the company faces financial difficulties, shareholders may experience a decline in the value of their shares.
Debentures: Debenture holders are creditors, and their returns are fixed. They receive interest payments regardless of the company’s profitability. However, they have a higher level of security in case of bankruptcy or liquidation, as they have a prior claim on the company’s assets before equity holders.
Convertibility:
Shares: Shares are non-convertible by nature. Shareholders do not have the option to convert their ownership into debt or any other form of security.
Debentures: Some debentures are issued with a convertible feature. Convertible debentures allow the holder to convert their debt into equity shares after a specified period, providing an option for the debenture holder to become a shareholder.
In summary, shares represent ownership in a company with voting rights and the potential for dividends and capital gains, while debentures represent a form of debt with fixed interest payments and a prior claim on the company’s assets in case of liquidation. Each has its own set of characteristics, and investors choose between them based on their risk tolerance, financial goals, and investment preferences.