Definition
Shares represent a portion of ownership in a company, giving the shareholder a claim on part of the company’s assets and earnings. On the other hand, debentures are a type of debt instrument, like a bond, that a company issues to raise capital, with a promise to repay the principal amount along with interest. Unlike shares, debentures don’t confer ownership, but give the holder a higher claim on assets than shareholders, in the event of liquidation.
Key Takeaways
- Shares are a unit of ownership in a company which gives the shareholder a claim to a part of the company’s earnings and assets. While, Debentures are a type of debt instrument that is not backed by security of the company’s physical assets or collateral.
- When an investor buys shares, they become a partial owner in the company. But in case of debenture, the company borrows money from the debenture holder and promises to repay the principal along with interest at a specified date.
- In the case of shares, the dividend (return) is not guaranteed and depends on the profits made by the company. In contrast, debentures guarantee regular interest payment, regardless of the company’s financial position.
Importance
The financial terms “shares” and “debentures” are fundamentally crucial as they represent two different ways a company can raise capital.
Shares are units of ownership interest in a corporation that provide for an equal distribution in any profits, if any are declared, in the form of dividends.
Shareholders, thus, have a residual claim to profits, and they bear the highest risk in the company.
On the other hand, debentures are a type of debt instrument that a company can issue to raise capital with the promise of paying back the principal and a return (interest). Debenture holders have a claim on the company’s earnings before shareholders do, making it a less risky investment.
Hence, the contrast between shares and debentures is of paramount importance as it relates to the risk-return trade-off potential investors must consider when investing in a company.
Explanation
Shares and debentures serve very different purposes in the world of finance, and are often used as sources of capital by companies. Shares (also known as stocks) are a form of ownership in a company. They serve as a way for a company to raise capital without the need for borrowing.
When you buy shares, you’re gaining partial ownership of the company and thus you’re entitled to a portion of the company’s profits. Companies issue shares to finance new projects, maintain ongoing operations, or expand their business, dramatically increasing their production and revenue potential. Debentures, on the other hand, are a type of long-term loans that a company can take from the public and are backed only by the overall creditworthiness and reputation of the issuer.
The primary purpose of issuing debentures is to raise debt capital. When a company issues a debenture, it’s essentially borrowing money from the debenture holders and agrees to repay it at a specified rate of interest at a future date. This provides companies with the capital they need without diluting ownership or control.
Unlike shares, debentures don’t give the holder any ownership in the company, rather it makes the holder a creditor of the company.
Examples of Shares vs Debentures
Apple Inc.: In 2021, Apple Inc. issued shares for its shareholders which represented ownership stakes or equities within the company. This enabled its shareholders to potentially receive dividends and to vote on certain company matters as they owned a certain segment of Apple. However, in 2013, Apple Inc. also issued $17 billion in debentures (bonds). These debentures didn’t give bondholders any ownership stake in the company but instead provided Apple with a debt it was required to repay. The holders of these debentures received regular interest payments and had the security of principal repayment after the bond matures.
British Government Bonds: The British government frequently issues debentures, known as Gilts, to fund national debt. Investors who buy these don’t become shareholders or part owners of the country, but are guaranteed regular interest payments and the return of the principal at the end of the term.
Microsoft: In 2016, Microsoft decided to raise funds for the acquisition of LinkedIn by issuing debentures of about $20 billion. The debenture holders were promised fixed returns irrespective of the company’s performance. On the other hand, Shares issued by Microsoft represent ownership in the company and the shareholders are entitled to dividends which depend on the company’s profits. Moreover, the shareholders are having the right to vote at the annual general meetings of the company which is not available to the debenture holders.
Sure, here is your FAQ section:
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Frequently Asked Questions: Shares vs Debentures
1. What are shares?
Shares represent a fraction of ownership in a company. Owning shares in a company gives the shareholder a right to part of the company’s profits and assets. It may also grant the shareholder voting rights on company matters.
2. What are debentures?
A debenture is a type of debt instrument used by companies and governments to raise capital. Debenture holders are creditors to the company and have a right to receive the repayment of their investment along with interest.
3. What is the main difference between shares and debentures?
The main difference lies in ownership. Shareholders are part owners of the company while debenture holders are creditors. Shares may come with voting rights and rights to profits, whereas debentures are a form of debt and holders are entitled to repayment of their investment along with interest.
4. Are there risks involved in investing in shares and debentures?
Yes, both have their risks. Shareholders carry the risk of the company not performing well and being unable to pay dividends, and their investment can lose value. Debenture holders carry the risk of the company defaulting on its debt payments.
5. Can the same company issue both shares and debentures?
Yes, a company can issue both shares and debentures. The decision to do so lies with the management of the company and is usually based on the company’s needs and financial strategy.
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Related Entrepreneurship Terms
- Equity Capital
- Debt Capital
- Shareholders
- Interest Rate
- Creditors
Sources for More Information
- Investopedia: This source offers a deep dive into all topics related to finance including the difference between shares and debentures.
- The Balance: The Balance provides clear, practical advice to help you make the best decisions in relation to your personal finances, including understanding shares and debentures.
- AccountingTools: This website is a great source for understanding key accounting and finance principles and applying them, with a helpful section on share and debentures.
- Corporate Finance Institute (CFI): CFI provides a wide range of free and paid courses for professionals and students interested in finance and investment. Information on their website sharpens understanding of shares vs debentures.
