Shares and debentures are common methods companies use to raise capital. A share is a unit of ownership that represents a proportion of a company's capital, while a debenture is a debt instrument used to raise borrowed funds. Shares represent equity capital, whereas debentures represent debt capital.. This article aims to provide a comprehensive understanding of shares and debentures, their types, and the key differences between them. Understanding these differences is crucial for investors to make informed decisions based on their financial goals and risk tolerance.
How does a company raise funds for its capital requirements?
In the Indian securities market, companies can raise funds for their capital requirements through equity instruments and debt instruments.
1. Equity instruments:
Equity instruments represent ownership in a company. When a company issues equity instruments, such as stocks or shares, it sells ownership stakes to investors in exchange for capital. Investors who purchase these stocks become partial owners of the company and may receive dividends and have voting rights in shareholder meetings. In India, companies can issue equity instruments through initial public offerings (IPOs) or follow-on public offerings (FPOs) on stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
2. Debt instruments:
Debt instruments represent loans made by investors to the company. When a company issues debt instruments, such as bonds or debentures, it borrows money from investors with the promise to repay the principal amount along with periodic interest payments. Unlike equity holders, debt holders do not have ownership rights in the company, but they have a higher claim on the company's assets in case of bankruptcy. Companies in India can issue debt instruments through public issuances or private placements, and they may be listed on stock exchanges or traded over-the-counter (OTC).
Both equity and debt instruments offer companies different avenues for raising capital, each with its own advantages and considerations. Companies often choose the mix of equity and debt instruments based on factors such as their capital structure, growth prospects, risk tolerance, and prevailing market conditions.
What are Debentures?
Debentures are debt instruments where investors lend money to the company and receive fixed interest payments.
When an individual invests in debentures, they lend money to the issuing company, becoming a creditor. The company promises to repay the principal amount along with periodic interest payments, known as coupon payments, at a predetermined interest rate.
Types of Debentures
Let us explore the different types of Debentures:
- Convertible Debentures: These debentures can be converted into equity shares of the issuing company after a specified period, allowing investors to participate in the company's ownership.
- Non-Convertible Debentures: Non-convertible debentures cannot be converted into equity shares and offer fixed interest rates until maturity.
- Secured Debentures: These debentures are backed by specific assets of the company as collateral. In case of default, the debenture holders have a claim on the underlying assets, providing an added layer of security for investors.
- Unsecured Debentures: Also known as "naked debentures," these do not carry any specific collateral. They are issued based on the company's creditworthiness and ability to fulfil debt obligations. Since they lack collateral, unsecured debentures typically offer higher interest rates than secured ones to compensate for the increased risk.
- Fixed-Rate Debentures: These debentures carry a fixed rate of interest throughout their tenure. The interest payments remain constant, providing predictable returns for investors.
- Floating Rate Debentures: The interest rate on these debentures fluctuates based on a benchmark interest rate (like a government bond rate) or a market index. As interest rates change, the coupon rate on floating rate debentures adjusts accordingly.
- Perpetual Debentures: Perpetual debentures have no fixed maturity date, meaning they do not have a specific repayment period. The issuer pays interest indefinitely until it decides to redeem the debentures. However, there might be specific call or redemption options for the issuer after a certain period.
- Callable Debentures: Callable debentures grant the issuer the option to redeem the debentures before their scheduled maturity date. This option benefits the issuer if interest rates decline, as they can call back the debentures and reissue new ones at a lower interest rate.
- Puttable Debentures: Puttable debentures provide the investor with the option to sell back the debentures to the issuer before maturity at a predetermined price. This feature benefits investors in case they need to access their investment before the scheduled maturity date.
- Zero Coupon Debentures: These debentures do not pay regular interest like traditional debentures. Instead, they are issued at a discount to their face value and redeemable at face value upon maturity, providing investors with the interest component as capital appreciation
What are Shares?
Shares, also known as stocks or equity, represent ownership in a company. When you invest in shares, you become a shareholder and acquire a proportional stake in the company's ownership and future profits. Shareholders may benefit from dividends, capital appreciation, and voting rights in corporate decisions. You can start investing in shares by opening a free Demat & trading account with Bajaj Financial Securities Limited.
Types of Shares
Explore the different types of shares as given below:
- Common Shares: Common shares are the most prevalent type of shares and entitle shareholders to ownership in the company. They provide voting rights, allowing shareholders to participate in major decisions and elect the board of directors. Common shareholders also have the potential to receive dividends if the company distributes profits to its shareholders.
- Preference Shares: Preference shares come with preferential treatment in terms of dividends and capital repayment. Shareholders with preferred shares receive fixed dividends at a specified rate before common shareholders receive any dividends. In the event of liquidation, preferred shareholders are also given priority in receiving their share of the company's assets.
- Ordinary Shares: The term "ordinary shares" is often used interchangeably with common shares. These shares represent the basic ownership units in a company and offer voting rights and potential dividends.
- Non-Voting Shares: Some companies issue non-voting shares, which do not carry any voting rights in the company's decision-making processes. While non-voting shareholders still have ownership in the company, they do not participate in voting on matters affecting the company.
- Dual-Class Shares: In certain cases, a company may have different classes of shares with varying voting rights. For example, Class A shares might have more voting rights per share compared to Class B shares. Dual class share structures are often used by founders and insiders to retain control of the company while raising capital from public investors.
- Redeemable Shares: Redeemable shares can be repurchased by the company at a specific time or at the option of the shareholder. The terms of redemption are predetermined and stated in the company's by laws.
- Cumulative Preference Shares: Cumulative preference shares ensure that if the company skips paying dividends in any year, the unpaid dividends accumulate and must be paid in the future before any dividends can be paid to common shareholders.
Difference between Shares and Debentures
Debentures |
Shares |
A debenture is a debt instrument issued by a company, usually for long-term purposes. It is not backed by any asset or security, and lenders receive a fixed income from the interest paid on it. |
A share represents an ownership stake in a company and entitles the holder to dividends if declared by the company. Shareholders are also entitled to vote at shareholder meetings and may receive other benefits such as bonuses. |
Debentures are typically unsecured and may have long-term maturity dates. As a result, the interest rate for debentures is usually lower than that of shares. |
Shares can be bought and sold on the stock exchange, providing investors with liquidity. The price of a share fluctuates according to market demand and supply. The return from shares is higher than from debentures and is not fixed. |
Debentures are generally considered to be safer investments than shares as they offer fixed income, and there is no risk of capital loss. |
Shares can provide a higher return on investment. However, they also come with more risk as they are subject to market fluctuations in price. |
Shares cannot be transformed into debentures |
Debenture holders can change their securities into shares. |
When debentures are offered to the public, a trust deed must be executed for them to take effect. |
It is not necessary to execute a trust deed while dealing in shares. |
It's important to note that the specific features and rights of equity and preference shares can vary depending on the company and its articles of association. Therefore, it is advisable to carefully review the company's share structure and associated rights before investing in any type of shares.
Shares vs Debentures - Which is the better investment choice?
Choosing between shares and debentures depends on several factors, including risk appetite, investment goals, and market conditions. Shares can offer higher returns through capital appreciation and dividends but come with greater volatility. Debentures provide stability through fixed interest payments but offer lower potential for capital growth.
If an individual seeks growth and is willing to take on market risks, investing in shares may be suitable. However, if an individual prefers stable income and lower risk, debentures can be a more suitable choice. Diversification is often recommended, allowing balance in risk and return by investing in both shares and debentures.
Conclusion
Shares and debentures are distinct financial instruments with unique characteristics. Shares represent ownership in a company and involve market risks, while debentures represent debt and offer fixed interest payments. Understanding the difference between shares and debentures is essential for making informed investment decisions. Assess your risk tolerance, investment goals, and market conditions to determine the right balance between shares and debentures in your portfolio. Always consult with a financial advisor before making investment choices to ensure they align with your financial objectives. Additionally, you must also remember that opening a Demat account is a crucial step to kickstart your investment journey. Hence, consider researching reputable broking firms or financial institutions that suits your investment needs.
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