There are different methods of investing in a company in which shares and debentures form some of the most extended ways. Though both represent ownership investment in a corporation, they have distinct features regarding ownership, rights, risks, and expected returns. Explaining the major Differences between Share and Debenture holders is basic knowledge that should be realized when engaging in investments. In this blog, however, I will discuss these differences with emphasis.
1. Nature of Ownership
Shares:
A share is a form of investment where one is invested on company ownership. For instance, when you buy shares you are actually a shareholder this is so because you own a part of the company. Shareholders are counterparts to the company and they own a part or portions of the company’s stocks. In this case, the concept of ownership means the degree of ownership that is invariably determined by the number of shares owned.
Debentures:
On the other hand, we have debt securities which include the debentures. When you buy debentures, you are actually giving out a loan to the business in question, hence making it a form of indebtedness. Total, you are not an owner in the company when you take a debenture with you as a debenture holder. Instead, you consider yourself as a secured party because you are a creditor with an interest in the company’s assets and the company is in turn legally bound to pay back the principal sum with interest.
Key Difference:
The shareholders are the company’s equity holders who are entitled to the claim of the company’s earnings and also on its properties.
Thus debenture holders areóthe creditors of the firm who have a charge on the assets of the firm, but do not have ownership rights.
2. Risk and Return
Shares:
As a general rule, the investment in shares is more risky compared with the investment in debentures. Facilities held through share also have the ability to change in value due to operations of the firm, general market conditions and even economic forces. On the one hand, shareholders can obtain high income in the form of dividends and increase their capital, on the other hand, they are subject to the risk of losing their invested funds, if the company’s performance is low or the company becomes bankrupt.
Debentures:
Debentures, on the other hand, affords lesser risk to its holders, Debentures returns on investment are fixed and received in the form of interest regardless of the proficiency of the company. In fact, even when the performance of a company is weak it is mandatory for it to pay interest on debentures. But the yields of debentures are relatively lower compared to potential yields of shares of stocks.
Key Difference:
Stocks have high returns but with even higher risks as compared to other securities.
Debentures offer relatively stable, but lower, returns with less risks than an equity interest.
3. Rights and Privileges
Shares:
All shareholders have some privileges because they are owners of the business entity; These include:
Voting Rights:This is in reference to the shareholder rights whereby common shareholders are entitled to have a say in major organizational issues like the appointment of the board of directors and various corporate management decisions.
Dividends: Some of the returns that shareholders may get include dividends which are part of the company’s profits that is distributed among shareholders. However, dividends are not fixed and are paid from the organization’s profits as per the decisions of the management.
Residual Claims:On the occasions of liquidation, shareholders come with the last priority in gaining access to the company’s remaining tangible resources after all creditors have been paid.
Debentures:
Debenture holders, unlike shareholders, are creditors and therefore there are limited rights given to them. In connection with the borrower, their rights are mainly linked to the repayment of the debt. Key rights include:
Interest Payments: Particularly, debenture holders are accorded a fixed amount of interest and are payable whether or not the business made profits.
Principal Repayment:The terms of debentures include redemption at par value at the end of the debenture period for repayment of the principal amount to the debenture holders.
Priority in Liquidation: With regards to liquidation, it is important to note that debenture holders enjoy a higher ranking than shareholders with regard to the amount and priority of the corporation’s assets due to them.
Key Difference:
The major benefits of shareholders are the right to vote, potential dividend receipts, and residual claims to assets.
Debenture holders do not have any voting rights but they can receive fixed interest payments and it has been seen that they have the right to claim the company’s assets in case of its liquidation.
4. Income Generation
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Shares:
The income for shareholders primarily comes from two sources: Dividends and capital gains. There are two main types of distributions which we have to differentiate: Dividends are the part of the company’s profits distributed to shareholders periodically, usually monthly or quarterly. Capital gains include changes in the value of the shares over time and this will enable shareholders to dispose of the shares at a higher price than what they paid.
Debentures:
Debenture capital earns its money by way of interest, which is usually specific and payable at specific times (for example annually or semi-annually). The interest rates are fixed at the time of issuing the debentures and the income received through them is in fact not a profit. The principal amount is also to be paid at the maturity date which is not the case with shareholders at any given time.
Key Difference:
The two ways through which shareholders are able to make their returns are by means of dividend and capital appreciation.
Debentures receive interest in a fixed amount and therefore are considered as sources of revenue.
5. Tax Implications
Shares:
Dividends as well as any gains from shares are also subjected to taxes. dividends are usually treated differently to ordinary income tax and capital gains are taxed on a basis of holding period being either short term or long term gains.
Debentures:
Even the interest received on debentures is paid after tax has been deducted. But this is subject to the normal tax rates as other forms of income and there are no zero percent taxation like in the case of dividend income or capital gains from investments held for over a year.
Key Difference:
Dividends received by the shareholders are also subjected to taxation and with much preferential rates in case of capital gains.
On the same note, the holders of Debentures are subjected to tax on the interest income received on their Debentures at the normal tax rates.
Read more – Dividend Investing: Portfolio for Passive Income and Passive Income Strategic Planning
6. Convertibility and Flexibility
Shares:
It can be mentioned that shares are usually non-immutable and it means that they cannot be exchanged for other types of securities. However, the concept of the share can also be segmented into classes like preferred shares and others with features such as conversion to common share under certain times.
Debentures:
While some debentures are fully paid, they may be fully paid with provision on the holder’s side to exchange them with shares in the company at a specific rate after some time. As for this feature, debenture holders are provided with the capacity of capital gains in case of excellent performance of the company’s shares. Convertible debentures also contain both the security features of a debenture and the potential for the growth of an equity.
Key Difference:
Most shares are non –convertible although there can be some special attributes in the preferred shares.
There are secured debentures that enable the companies to become convertible debentures that give the option of converting them into share capital.
You may also check out the link – What are the two classes of stock and stock market- a detailed discussion
Conclusion
Thus the key difference between share and debenture holders considers the nature of the investment made by each of them. It is the major investor who has full control of the company through the voting rights of shares that they own has the direct equity interest in the firm’s profits and assets, potential high returns though with higher risk taking. Like any other debt financing, the debenture holders have a fixed income and relatively lesser risk compared to the equity shareholders but no controlling rights or the possibilities of a large appreciation in their investment.
