Difference between Shares and Debentures

Investing in stocks and securities can be extremely beneficial for generating long-term wealth. To do that efficiently, it is imperative to have a proper understanding of the market and certain key concepts. One such aspect is to know the difference between shares and debentures.

As a new investor, you must remember that you can start trading in stock markets, only after opening a trading account and Demat account. A trusted stockbroker can provide you with a free online Demat account and trading account in India.

To understand shares and debenture, let’s begin by understanding the ways a company raises its funds.

How does a company raise funds for its capital requirements?

A company can raise funds for its business through:

  • Equity instruments: These are known as shares. Once a listed company offers its shares or stocks through Initial Purchase Offerings (IPOs), the public gets a chance to become part-owners of the company by purchasing the shares.
  • Debt instruments: A company can also choose to fund its businesses through loans. A company can issue debentures, which are primarily debt instruments entailing regular interest payouts. Once you purchase debentures of a company, you become its creditor.

Understanding shares of a company:

After purchasing shares of a company, you become a part-owner of the company, in proportion to the shares you have bought. Apart from the profits of the company, shareholders also receive income from dividend payouts. Shareholders also receive the right to vote on decisions of the company.

Types of shareholders:

Generally, there are two types of shareholders:

  • Common shareholders: These comprise the majority of a company’s shareholders. A common shareholder can vote on the company’s decisions and is entitled to receive dividend payouts.
  • Preferred shareholders: While these shareholders do not have any voting rights, they are given priority in making repayments, if the company gets liquidated.

Understanding debentures of a company:

  • These are primarily debt instruments to raise long-term loans for the company. Typically, debentures are backed by the creditworthiness of the issuing company.
  • Unlike shares, ownership of debentures will not make you part-owner, nor will you receive benefits of dividends, or any voting rights. You are simply a creditor of the company, with the right to receive a fixed interest rate.
  • You can purchase debentures either in the secondary market or when they are issued for the first time.

Types of debentures:

There are two types of debentures being issued by companies:
  • Convertible debentures: These debentures can be converted into stocks or shares in the future.
  • Non-convertible Debentures (NCDs): These don’t provide the option of being converted into stocks at any point in time. NCDs can be further divided:
    • Secured debentures: These are secured by some underlying assets of the company. Interest payouts in secured debentures are less when compared to unsecured debentures.
    • Unsecured debentures: Also known as naked debentures, these are not secured by any company asset. These provide higher rates of interest vis-à-vis secured debentures.

Risks associated with investments in Non-convertible Debentures:

Before making investments in NCDs, you must always consider the risk factors. Typically, NCDs have three types of associated risks:

  • Inflationary risks: These arise because of the rise in prices. Inflationary risks can eat into the returns received as interest payouts.
  • Interest rate risk: Sudden drops in interest rates can negatively impact debenture holders.
  • Default risk: This is a risk in the case of the company defaulting on its obligation to provide interest payouts.

To mitigate the associated risks with investments in NCDs it is important to check the past performance of the company along with conducting market research about its financial position. You can also check a company’s credit ratings by primary rating agencies such as ICRA and CIRIL.

Difference between shares and debentures:

You can refer to the chart given below to know the differences between the two financial instruments

Features Shares Debentures
Definition These represent equity These represent debt
Returns from investments You receive dividends You receive interest payouts
Access to voting rights Yes No
Convertibility features Cannot be converted into debentures Convertible debentures can be converted into stocks
Types Common shareholders and preferred shareholders Convertible and Non-convertible Debentures
Representatives Stockholders are part-owners Debenture holders are creditors
Risk of investment Have high market risks because of being exposed to market volatility Have lower risks because of lower exposure to market volatility
Returns Provide high returns Provide moderate to low returns

Conclusion

You can decide to invest in either shares or debentures (or both) based on your short-term and long term financial goals. Your investment decision must also be based on your risk appetite. While debentures are low-risk securities with a fixed income payout, shares are relatively riskier, but also offer high upside potential for long term wealth generation. For investing both in shares and debentures, you are required to open a trading account and a Demat account. Selecting a reliable and trusted stockbroker can provide you access to the best trading account in India.