Introduction
Gone are the days of saving money to invest in Fixed Deposits. People have started realizing the importance of sound financial decisions. With the advent of social media, numerous content creators have ventured into the field of financial literacy and strongly promote investing in equities. But in reality, it is not as easy as it sounds. Before investing money, one must ensure that they are aware of certain basic terms and concepts. In this article, we will be covering the basic concept of shares and debentures and would help you in understanding the key points of difference between a shareholder and a debenture holder.
Shares are a part of the Share Capital of the Company. A shareholder that owns a share can be said to be an owner of a part of the share capital. That is one of the reasons why shareholders are known as the owners of the company. The Supreme Court of India in CIT v. Standard Vacuum Oil’s[i] case had even stated that a share is actually not any amount of money, in reality, it is an interest that can be measured by a sum of money and comprises of various rights are enjoyed by the shareholders owing to the Articles of Association the Company which constitute a contract between him and the Company”. Shares can further be bifurcated into Equity Shares and Preference shares. Equity shares usually do not have preferential rights. Even the dividend paid on Equity shares keeps fluctuating every year. An equity shareholder has the right to vote on issues that affect the company, on the other hand, a preference shareholder can vote only when his special rights as a preference shareholder are being varied. A preference shareholder can also vote when their dividend is in arrears for at least 2 years.
What Are Debentures?
The Latin word ‘debere’ which means to borrow. The word debenture was derived from the aforesaid Latin word. Gower, L.C.B., said “Debenture is a name applied to certain types of documents evidencing an indebtedness which is normally but not necessarily secured by a charge over property”. Section 2(30) of the Companies Act the term ‘debenture’ is defined in the following manner – “Debenture includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.” Nonetheless, as per other laws, certain instruments are not categorized as debentures even if they fit the definition of debenture. For instance, the Companies (Amendment) Act, 2017, the instruments that are referred to in Chapter III-D of the Reserve Bank of India Act, 1934; and similar other instruments, that have been prescribed by the Central Government in consultation with the Reserve Bank of India, issued by a company, shall not come under the treated the ambit of debenture. Debentures are movable property which are transferable in accordance with the provisions of the Articles of Association of the respective company
The following are the primary features of a debenture:
- They are categorized as movable property.
- They are issued by the company.
- They act as a certificate of indebtedness.
- Debentures mention the date of redemption, for the repayment of principal and interest at specified dates.
- At times, debentures end up creating a charge on the undertakings of the company.
Is Debenture Stock Same As Debenture?
Debenture and Debenture Stock are more or less the same thing as the latter creates one loan fund called “debenture-stock”. This is divisible among a class of lenders who own a certificate for these debenture-stock which basically mentions the parts of the entire loan to which the holder is entitled to. Lord Lindley was of the opinion that the borrowed capital consolidated into one mass for the sake of convenience would be regarded as debenture stock. While a single debenture can be transferred as a single entity, a debenture stock can be sub divided and transferred. Also, debenture stocks are usually fully paid, that might not be the case with debentures.
In order to understand the difference between a share holder and a debenture holder, we must first understand the difference between a share and a debenture. A share and a debenture can be distinguished in the following manner:
- Debentures is a loan while the shares constitute a part of the capital of a company.
- Debenture holders can be called the creditors of the company, while the Shareholders are the owners/members.
- At times Debentures create a charge on the assets which is not created while issuing shares.
- Debentures can be issued at discount, while the shares of a company cannot.
- While debentures enjoy an interest even when the company incurs no profit, dividends can only be issued when the company incurs profit.
- It is pertinent to note that the Interest paid on debenture is a business expense and can be deducted from profits, but the dividend given on shares is not to be treated as business expense.
- Following the aforementioned point, it can also be stated that the interest on debentures is fixed and the dividend on equity shares is dependent on the profits and the decision of the board of directors.
- The interest paid on debentures is given priority over the dividend paid on shares.
Now that we have understood key points of difference between shares and debentures, it will be easier for us to understand the difference between a shareholder and a debenture holder.
1) The difference between a shareholder and a debenture holder is that of a member and a lender. While a shareholder can be regarded as a member of the company, a debenture holder is nothing more than a lender as long as he owns debentures.
2) If you invest in the share market, you must be aware of the fact that not every company gives dividend on its shares. Certain Indian Companies that are known to give dividends to their shareholders are Wipro and ITC. But let us assume, that if one of these Companies incurs losses in a financial year, would they still give their shareholders dividend? The answer to this question is no because dividends can only be issued from profits of the Company. Moreover, as stated before, not every company gives dividends to its shareholders even if they incur profits, it’s an optional practice. While speaking of debentures, the tables turn. Debenture holders are entitled to a fixed rate of interest irrespective of whether the company incurs a profit or a loss in that financial year or quarter. Therefore, we can say that dividend depends on the profits of the company, while interest on debenture is to given irrespective of profit or loss.
Following the above mentioned point, we can say that the rate of interest paid to debenture holders is usually fixed while that amount of dividend is not certain.
3) The Company can mortgage the property/assets against the debentures held by the debenture holder but the same cannot be done in the case of shares.
4) Voting rights are the right possessed by the members of a company to vote in a meeting of the company or by means of postal ballot. It is pertinent to note that shareholders possess the right to vote. A debenture-holder is devoid of such a right. In fact, a section[ii] of the Companies Act even states that a company is forbidden from issuing debentures that carry voting rights.
5) The interest paid on debentures, is a charge against the profits. The interest is deducted from the revenue. On the other hand, dividends paid on shares cannot be said to be a charge against profit.
6) In the event of winding-up, shareholders are not given priority over the outside creditors when it comes to payment. It is seen to it that the outside creditors are being paid in full. On the contrary, Debenture-holders are secured lenders, this is because they have prior claims for repayment unlike shareholders of a company.
7) Unlike shareholders of a Company, debenture holders own no rights to participate in the decision making process of the company. Moreover, the board of directors, that have an active say in the management of affairs of the company, is comprised of certain shareholders of the company.
8) Redemption of debentures is possible but equity shares cannot be redeemed.
9) While the value of shares keeps changing depending on various market conditions and sentiments, the value of debentures is not fluctuating.
Conclusion
While understanding the structure of a company, one simply cannot avoid studying shares and debentures. That being said, there’s a drastic difference between a shareholder and a debenture holder. While one owns a part of the share capital, the other simply acts like a lender or creditor and gets debentures in return for it. The rights of shareholders and debenture holders do not collide with one another and are quite different, therefore, it essential to study the difference between the two.
References
- Company Law by Taxmann, 24th
- Company Law Module (2021) by ICSI.
- https://www.shaalaa.com/question-bank-solutions/shareholder-debentureholder-debentures-bonds_51083
- https://www.indiainfoline.com/article/news-sector-others/differences-between-shareholders-and-debentures-holders-113111501092_1.html
- https://www.motilaloswal.com/blog-details/Understand-the-difference-between-shareholder-and-debenture-holder/20092#:~:text=Shareholders%20are%20the%20owners%20of,in%20the%20decision%20making%20process.
[i] CIT v. Standard Vacuum Oil Co. [1966] Comp. LJ 187
[ii] Sub-section (2) of Section 71 of the Companies Act, 2013
