What is a debenture? How does it differ from a share?

Debenture vs. Share: Understanding the Differences

1. Definition of Debenture:

• Debenture is a type of debt instrument issued by a company or government that acknowledges a loan and specifies the terms under which the loan must be repaid, including the interest rate and maturity date. Debentures are typically unsecured and backed only by the creditworthiness of the issuer.

2. Definition of Share:

• Share represents ownership in a company and entitles the shareholder to a portion of the company's profits and assets. Shares are issued by companies to raise capital and can be of different types, such as equity shares and preference shares.

3. Nature of Instrument:

• Debenture: Debenture is a debt instrument, meaning it represents a loan to the issuer and carries a fixed rate of interest. Debenture holders are creditors of the company and have no ownership rights in the company.
• Share: Share is an equity instrument, meaning it represents ownership in the company. Shareholders are owners of the company and have voting rights and the right to receive dividends.

4. Security:

• Debenture: Debentures can be secured or unsecured. Secured debentures are backed by specific assets of the company, which can be sold to repay debenture holders in case of default. Unsecured debentures are not backed by any specific assets.
• Share: Shares are not secured by any specific assets of the company. Shareholders' claims are residual, meaning they are entitled to the remaining assets of the company after all other claims, including those of debenture holders, have been settled.

5. Priority of Payment:

• Debenture: In case of liquidation or bankruptcy of the company, debenture holders are paid before shareholders. Secured debenture holders are paid first, followed by unsecured debenture holders.
• Share: Shareholders are paid last in case of liquidation or bankruptcy, after all other claims, including those of creditors and debenture holders, have been settled.

6. Interest vs. Dividend:

• Debenture: Debenture holders receive fixed interest payments at regular intervals, usually semi-annually or annually. The interest rate is specified at the time of issuance and does not change.
• Share: Shareholders receive dividends, which are payments made by the company out of its profits. The amount of dividend is not fixed and is determined by the company's board of directors.

7. Convertibility:

• Debenture: Some debentures are convertible into shares of the issuing company at a predetermined conversion ratio and price. This gives debenture holders the option to convert their debt into equity.
• Share: Shares are not convertible into debt. However, some companies issue convertible preference shares, which can be converted into equity shares after a certain period.

8. Voting Rights:

• Debenture: Debenture holders generally do not have voting rights in the company's affairs. Their relationship with the company is purely contractual.
• Share: Shareholders have voting rights and can participate in the company's decision-making process, such as electing the board of directors and approving major corporate actions.

9. Risk and Return:

• Debenture: Debentures are considered less risky than shares because they have a fixed rate of interest and priority of payment in case of liquidation. However, they offer lower returns compared to shares.
• Share: Shares are riskier than debentures because their value fluctuates with the company's performance and market conditions. However, they offer the potential for higher returns through capital appreciation and dividends.

Conclusion:

• In conclusion, debentures and shares are two distinct financial instruments with different characteristics and features. Debentures represent debt and provide a fixed return, while shares represent ownership and offer the potential for higher returns but also higher risk. Understanding the differences between debentures and shares is important for investors and companies seeking to raise capital.