If a person has plans to invest in stocks and securities, he must have a clear understanding of the intricacies of the market. You need to be wise while making market investments. One such aspect is to learn to distinguish between shares and debentures.
How Can a Company Raise Capital Funds?
There are primarily two means by which a company can raise its capital funds and this constitutes shares and debentures.
Equity instruments-Shares
Shares are small equity amounts into which a company’s capital is divided. After a company gets listed on the stock exchange, it offers its shares for investors to purchase through IPOs. All those who own shares of a company become its part owners and take part in the company’s proceedings. A shareholder owning more than 50% of the company’s shares become its biggest owner. Shareholders earn returns in the form of dividends out of profits the company makes.
Debt instruments- Debentures
Debentures also help to raise the company’s funding but there’s a difference between share and debenture. It is a debt instrument issued by lenders like a bank while offering capital to the company. Their objective is to raise long-term loans for the company. Debenture holders of a company become its creditors. Lenders secure loan repayments against the company’s assets through debentures.
Which One is a Better Investment Option?
Shares and debentures have their own pros and cons. They are superior in their own field of application. We cannot pass a general dictation that one is a better investment option than the other. The investor must analyse the situation well and choose either of the two according to the growth, capacity and requirements. While shares help the company to expand during its start, debentures provide priority during liquidation. In order to know how to apply them, an investor must know the critical differences between share and debenture.
1. Shared Capital
The capital type for shares is owned capital, the fundamental capital of the company.
The capital type for debentures is borrowed capital. It is the acknowledgement the company gives to lenders in the form of mortgaged assets.
2. Optional nature
It is compulsory for every company to issue shares. On the other hand, debentures are just an option for companies.
3. Return policy
Shareholders get returns from the profits the company makes, known as dividends.
Creditors receive returns in the form of interest payouts. It doesn’t require the company to be profitable. The nature of the interest is floating or fixed.
4. Role of investors
Shareholders are part owners of the company and have rights to take company decisions like who will run the company. They enjoy voting rights. Shareholders are entitled to both profits and losses of the company and are the actual risk bearers. Their investments do not carry any security.
Debentures holders are just creditors to the company and do not have any such power. Debenture holders are much less prone to risks than shareholders as they have a lien over the company’s assets. In fact, debentures are one of the most secure investment tools.
5. Priority during liquidation
Another important difference between share and debenture, during liquidation, debenture holders are given their due payoffs first. Shares carry residual interest over the asset, remaining after all repayments.
It is not mandatory for the company to return the shareholders the share capital. But the company must pay all the interests and dues to the debenture holders.
6. Convertibility
Shares cannot be converted to debentures Or any other form of capital structure. On the other hand, debentures can be converted into company capital and shares too.
Thus, as discussed before, you can understand that they have their unique properties. You can’t tell from the difference between share and debenture, which one is a better investment option in general. You have to decide which one would be better in your present situation.
