Debenture Vs Shares

The main difference between debenture and shares is that debentures are a type of debt instrument where the company borrows money and pays fixed interest, while shares represent ownership in the company, where shareholders receive dividends based on the company’s profits.

What Do You Mean By Share?

A share refers to a portion of ownership in a company. When someone buys a share, they essentially become a part-owner of that company and may receive a portion of the company’s profits, typically through dividends. Shares are traded on stock exchanges.

Shares are primarily categorized into equity shares and preference shares. Equity shareholders typically benefit from the company’s profit distribution in the form of dividends, and they have the right to vote on important company matters. Preference shareholders receive a fixed dividend but generally do not have voting rights. Companies issue shares to raise capital for expansion or operations, offering investors an opportunity to invest and grow their wealth.

If an individual buys 100 shares of a company at ₹50 per share, their total investment is ₹5,000. If the share price later rises to ₹70, the value of their shares would increase to ₹7,000, offering a potential profit.

What Is The Meaning Of Debenture?

A debenture is a financial tool that companies use to borrow money from investors. It acts as a long-term loan, where the company agrees to pay periodic interest and return the principal amount at a later date. Unlike shares, debentures don’t grant ownership rights.

Debenture holders are considered lenders to the company and are entitled to fixed interest payments, irrespective of the company’s financial performance. Companies issue debentures to raise funds for growth or operations. These instruments can be secured or unsecured, with some being backed by company assets to ensure repayment.

If an investor buys a debenture worth ₹1,00,000 from a company at an interest rate of 8%, they will receive ₹8,000 per year as interest, regardless of how the company performs.

Difference Between Debenture and Shares

One primary difference between debenture and shares is that debentures represent a loan given to the company, where the holder receives fixed interest, while shares represent ownership, entitling shareholders to dividends based on the company’s profits. 

Types of Shares

Types of shares include equity shares, preference shares, bonus shares, rights shares, and sweat equity shares. These categories represent different rights and privileges for shareholders, ranging from voting rights and dividend priorities to special share distributions for employees and existing investors.

1. Equity Shares:
   Equity shares represent part-ownership in a company and provide shareholders with voting rights. Dividends are paid based on the company’s profits, but shareholders bear higher risk, as they are the last to be compensated in case of liquidation. Equity shares are the most commonly traded in the stock market.
   

If you purchase 100 equity shares at ₹50 each, you invest ₹5,000. If the company performs well and the price increases to ₹70 per share, your investment rises to ₹7,000. You may also receive dividends based on the company’s profitability.

2. Preference Shares:
   Preference shares give holders a fixed dividend payment and priority over equity shareholders in receiving dividends. However, preference shareholders usually do not have voting rights. These shares are preferred by investors seeking a more stable income, as dividends are assured regardless of the company’s profit fluctuations.
   

If you hold 100 preference shares with a fixed dividend of ₹5 per share annually, you will receive ₹500 every year, even if the company’s profits vary. Although you won’t have voting rights, you have priority for dividends over equity shareholders.

3. Bonus Shares:
   Bonus shares are issued to existing shareholders free of charge when a company has surplus reserves. This increases the shareholder’s total holdings without requiring additional investment. Companies issue bonus shares to reward shareholders and increase liquidity in the market.
   

If you own 200 shares and the company announces a 1:5 bonus issue, you will receive 40 additional shares, bringing your total holdings to 240 shares. This increases your investment in the company without spending additional money.

4. Rights Shares:
   Rights shares are offered to existing shareholders at a discounted price, allowing them to buy additional shares before they are offered to the general public. This method helps companies raise additional capital while giving shareholders an opportunity to increase their ownership at a lower cost.
   

Suppose you own 100 shares and the company offers 20 rights shares at ₹40 (while the market price is ₹50). You can purchase the extra shares at a discount, increasing your total holdings to 120 shares at a lower price than the market rate.

5. Sweat Equity Shares:
   Sweat equity shares are issued to employees or directors as a reward for their contributions to the company. These shares are given in recognition of the value they have added through their expertise or services, allowing them to have ownership without purchasing shares upfront.
   

Suppose an employee who has significantly contributed to the company’s growth might be given these shares. Let’s say Mr. Anuj receives 1,000 sweat equity shares at ₹100 each without needing to pay for them. This allows Mr. Anuj to benefit from the company’s success and future profitability.

Types of Debentures

Types of debentures include convertible debentures, non-convertible debentures, secured debentures, unsecured debentures, redeemable debentures, and irredeemable (perpetual) debentures. These debentures vary based on conversion rights, security backing, and repayment terms, offering different levels of risk and return to investors.

1. Convertible Debentures:
   Convertible debentures can be converted into equity shares after a specified period. Investors benefit from the fixed interest payments initially and the potential for capital appreciation if they convert their debentures into shares when the company’s stock performs well, providing both stability and growth potential.

If you hold ₹1,00,000 worth of convertible debentures, you receive fixed interest annually. After 5 years, you can convert them into equity shares at a predetermined rate, benefiting from share price appreciation if the company’s stock performs well in the market.

2. Non-Convertible Debentures (NCDs):
   Non-convertible debentures cannot be converted into equity shares. Investors earn fixed interest payments throughout the tenure and receive the principal amount at maturity. These debentures offer steady income but do not provide the opportunity to benefit from equity ownership or share price increases.

If you invest ₹1,00,000 in non-convertible debentures at an interest rate of 8%, you will receive ₹8,000 per year as interest and get back your ₹1,00,000 principal amount when the debenture matures.

3. Secured Debentures:
   Secured debentures are backed by the company’s assets, providing investors with added security. In case of default, the company’s assets can be sold to repay debenture holders. These debentures are less risky than unsecured ones, offering more protection to investors.
   

If you purchase ₹1,00,000 worth of secured debentures, the company pledges its assets (such as property) as collateral. In case of default, the assets can be liquidated to repay the amount you are owed.

4. Unsecured Debentures:
   Unsecured debentures are not backed by any company assets, making them riskier than secured debentures. Investors rely on the company’s creditworthiness to receive interest payments and the principal amount at maturity. These debentures often offer higher interest rates to compensate for the increased risk.
   

If you invest ₹1,00,000 in unsecured debentures with an interest rate of 9%, you will receive ₹9,000 annually. However, if the company defaults, you may not have any asset-backed guarantee for repayment.

5. Redeemable Debentures:
   Redeemable debentures have a fixed maturity date, and the company repays the principal amount at the end of this period. Investors receive regular interest payments during the term of the debenture, and their capital is returned when the debenture matures.

If you buy ₹1,00,000 of redeemable debentures at a 7% interest rate, you will receive ₹7,000 annually, and after 5 years, the company will return your ₹1,00,000 principal amount.

6. Irredeemable (Perpetual) Debentures:
   Irredeemable debentures, also known as perpetual debentures, do not have a fixed maturity date. The company is not obligated to repay the principal, but it must continue to pay interest to the debenture holders indefinitely, as long as the debenture remains outstanding.
   

If you invest ₹1,00,000 in irredeemable debentures at a 6% interest rate, you will receive ₹6,000 annually without expecting the principal repayment, as these debentures continue indefinitely.

We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:

Debenture Vs Shares – Quick Summary

• One of the main distinctions between debentures and shares is that debentures represent a loan to a company with fixed interest payments, while shares give ownership in the company and dividends based on profits.
• Shares represent a unit of ownership in a company, offering shareholders the potential to earn dividends and gain voting rights. Shareholders benefit from company profits but also bear the risk if the company underperforms.
• A debenture is a financial instrument where a company borrows funds from investors, paying fixed interest. Unlike shares, debenture holders do not own part of the company, but they are prioritized for repayment before shareholders in case of liquidation.
• The key difference between debentures and shares is that debentures are loans to a company with fixed interest payments, while shares represent ownership with dividends based on company profits.
• Shares include equity shares, preference shares, bonus shares, rights shares, and sweat equity shares. Each type offers different rights, such as voting, dividends, or additional shares for employees or existing shareholders.
• Equity shares give ownership with voting rights and dividends based on profits, while preference shares offer fixed dividends but no voting rights. Bonus shares are free to existing shareholders, rights shares are sold at a discount, and sweat equity shares reward employees.
• Debentures are classified as convertible, non-convertible, secured, unsecured, redeemable, and irredeemable (perpetual). These types vary in terms of conversion rights, security backing, and whether or not the principal is repaid.
• Convertible debentures allow conversion to shares, non-convertible debentures offer fixed interest without equity conversion, secured debentures are asset-backed, unsecured debentures carry higher risk, redeemable debentures have a fixed repayment, and irredeemable debentures pay interest indefinitely without repaying the principal.
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Difference Between Debenture and Shares – FAQs