When we talk about options for investment, the most common options available to investors are equity and debt instruments. A good or healthy combination of the two makes a balanced portfolio where the investors can reduce the overall portfolio risk as well as gain good returns. Shares and debentures are both issued by companies as a way to raise funds. However, these are fundamentally different investment instruments.
Given below is the meaning of shares and debentures and details of the basic differences between the two.
Stocks or shares are issued by the corporates as a mode of raising capital. Investors can invest in the shares of any company by buying the shares from the open market or by subscribing to the IPO. Investing in shares of a company provides the investor with ownership rights as well as voting rights.
Investment in shares is further classified based on various parameters like
- Shares of growth-oriented or dividend-oriented companies
- Shares of companies based on their market capitalization
- Shares of companies based on their origin or incorporation
- Shares of companies belonging to a particular sector or industry.
Types of shares
Shares are essentially classified under two main heads – equity shares or ordinary shares and preference shares. Both these shares form the capital of the company. However, preference shares do not provide voting rights. Also, preference shares get a priority in receiving dividends as well as the value of their investment at the time of liquidation.
What is the meaning of Debentures?
Debentures are a very common debt instrument issued by companies. These are used to raise capital at a fixed rate of interest paid to the debenture holders. This makes them in the nature of a loan taken by the company from the general public which may or may not be redeemed depending on the type of debentures.
Types of debentures
The basic types of debentures are mentioned below.
- Secured debentures
Secured debentures are the debentures that are backed by an asset of the company which can be liquidated to recover the interest and redemption value.
- Unsecured debentures
Unsecured debentures do not have any charge on any asset of the company. So debenture holders will have to wait after the secured debenture holders to get their value of the investment at the time of liquidation.
- Convertible debentures
Convertible debentures are the debentures that can be converted to equity shares at the time of redemption.
- Non-convertible debentures
Non-convertible debentures cannot be converted to equity shares upon redemption.
- Registered debentures
Registered debentures are where the names of the debenture holders are mentioned as per the register of the company.
- Bearer debentures
In the case of bearer debentures, no name is registered under the records of the company and they can be easily transferred to any person.
Shares and debentures are two very distinct types of instruments issued by a company. The target investors for each category depend on their basic characteristics and the expectations of the investors. Shares are considered to be a highly risky investment option and are therefore ideal for investors with a high-risk appetite. On the other hand, debentures are ideal for investors who have a lower risk appetite and are looking for a fixed income option.
Before we discuss the differences between the shares and debentures, let us first consider the similarities between the two.
- Shares and debentures are both instruments issued by a company (public limited or private limited company)
- Shares and debentures can be issued to the general public to generate funds for the company.
- Both shares and debentures can be issued at a discount or at a premium depending on the value of the company or its market capitalization.
After discussing the meaning and similarities between the terms shares and debentures, let us discuss the differences between them.
| Category | Shares | Debentures |
| Meaning | Shares are owners’ funds that form the capital of the company and the investors are known as shareholders. | Debentures represent the borrowed funds of the company or debt of the company and the investors are known as debenture holders. |
| Returns | The returns from shares are in the form of dividends that may or may not be declared every financial year as well as capital gains at the time of redemption of investment. | The returns from debentures are in the form of fixed interest paid to the debenture holders every year till the time that is redeemed as well as capital gains at the time of redemption of the investment. |
| Risk | Shares are a highly risky form of investment as they are greatly affected by market volatility. | Debentures are relatively less risky than shares. Also if the debentures are secured and backed by an asset of the company, debenture holders are further assured of their investment. |
| Preference upon liquidation | Shareholders are the last to receive any share at the time of liquidation after debenture holders and preference shareholders. | Debenture holders get a preference over shareholders to receive the value of their investment at the time of liquidation. |
| Treatment of profit | Dividends are declared out of the net profits of the company. | Interest on debentures is a charge on the profit or an expense of the company and is deducted to arrive at the net profits. |
| Voting rights | Shareholders get voting rights. | Debentures holders do not get any voting rights. |
| Taxation in the hands of investors | Dividends received on shares are taxable in the hands of the investors at their applicable slab rates. STCG on shares is taxed at a flat rate of 15%. LTCG is taxed at 10% after the initial exemption of up to Rs. 1,00,000 | Interest from debentures is taxed as per the applicable slab rates along with STCG. LTCG is taxed at the rate of 20% after indexation. |
Conclusion
Shares and debentures are an integral part of every company and common instruments to raise funds. The investment decision between shares and debentures depends on many factors like risk profile and returns expectations of the investors and their investment horizon. A good portfolio will have a healthy mix of shares and debentures to balance the risk and maximize investors’ wealth.
FAQs
Preference shares are part of the share capital of a company but have a preference in receiving dividends at a fixed rate over the ordinary shares or equity shares.
Yes. A person can invest in shares and debentures of a company without any restrictions.
The returns from investment in shares are in the form of dividends and capital gains.
No. LTCG is taxed at the flat rate of 10% without the benefit of indexation.
Perpetual debentures are debentures that are not redeemed or have no definite maturity period.
