Difference Between Shares And Debentures

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6) Difference between Shares and Debentures

Meaning of Shares

According to section 2(84) of the Indian companies act 2013, a ‘share’ means a share in the share capital of a company. Shares are the ownership capital that is held by the owners of the company. The holders of the shares are considered as owners of the company and enjoy various rights.

A share is a right to a specified amount of the share capital of a company, carrying with it certain rights and liabilities, while the company is going concerned or under the winding-up process. It represents the interest of the holder measured for purpose of liability and the dividend by a sum of money.

The memorandum and articles of association prescribe the rights and obligations of a shareholder

Kinds of Shares

According to section 43 of the Companies Act 2013, there are two types of shares

Equity shares
Preference shares

1. Equity Shares

All the shares are Equity shares which are not Preference shares. Unusually, Equity shareholders take dividends out of profits after payment of dividends to Preference shareholders. Equity shares have voting rights and this voting right will be proportionate to one’s share of the paid-up equity capital.

Equity shares are long-term financing sources for any company. These shares are issued to the general public and are non-redeemable in nature. Investors in such shares hold the right to vote, share profits and claim assets of the company. The value in the case of equity shares can be expressed in various terms like par value, face value, book value etc.^[1]

Benefits of Equity shares

i. Fair liquidity: – Share processes are directly proportional to fluctuations in the market or to the company’s revenue generation. They may even be affected by both.

ii. Profitability: – Investors not just benefit from the capital appreciation feature of equity shares but also earn regular dividends on their investments.

iii. Control on management: – Shareholders with a significant percent of shareholding can influence a company’s management significantly.

Types of Equity shares

i. Ordinary shares: – To procure funds ordinary shares are issued by the company to meet long-term expenses borne by the business. Any individual having a maximum number of these shares have substantial voting rights.

ii. Preference equity shares: – These shares are generally issued to an investor as a guarantee of the payment of cumulative dividend before returns are distributed among the shareholders. Preference equity shareholders do not have voting and membership rights.

iii. Bonus shares: – These shares are issued out of retained earnings of a business, wherein all the profits are distributed among the investors in the form of an additional stake in a company.

iv. Rights shares: – These shares are issued by a company to premium investors at a discounted price as an invitation to increase its stake in a repetitive business. A firm only sells shares to rights for a stipulated time to raise the required finances to meet its expenditures incurred.^[2]

2. Preference Shares

According to section 43 of the companies act 2013, “Preference share capital”, with reference to any company limited by shares, means that part of the issued share capital of the company which carries a preferential right with respect to-

i. Payment of dividend, either as a fixed amount calculated at a fixed rate.

ii. Repayment, in case of a winding-up or a repayment of capital, of the amount of the share capital paid-up or deemed to have been paid up, whether or not, there is a preferential right to payment of any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company.

Like equity shares, preference shareholders are also partial owners of a company. However, they are not entitled to voting rights and hence do not really possess the power to control or Influence Company oriented decisions. And they do not have a claim over bonus shares.

Types of Preference shares

i. Cumulative preference share: – When profits of a company are distributed amongst the shareholders, the holder of these shares is entitled to a dividend at a fixed rate.

ii. Non-cumulative preference share: – Holders of these shares are entitled to take dividends only out of the current year’s profit. No arrears are carried over a time period to be paid at the end of the term.

iii. Participating preference shares:– Normally, preference shareholders are entitled for a dividend at a fixed rate, but sometimes these shareholders are also entitled to participate in that surplus profits which remain even after the payment of dividend to equity shareholders.

iv. Non-participating preference shares: – Those preference shares which do not carry the rights to share in surplus profit.

v. Redeemable preference shares: – if a company is authorized by its article of association, it may issue Redeemable preference shares. These shares are issued for a fixed term, and they are paid off after the expiry of this year.

vi. Irredeemable preference shares: – Those shares the amount of which cannot be returned by the company to the holders of such shares unless the company is wound up.

vii. Convertible preference shares: – These are those shares that are entitled to be converted into equity shares within a certain period of time.

viii. Non-convertible preference shares: – Those preference shares which do not carry a right to be converted into equity shares.^[3]

Meaning of Debenture

The word debenture has been derived from the Latin word ‘debere’ which means to owe. A debenture is a bond, usually under the common seal of the company and secured by a charge on the company’s property or undertaking, bearing a fixed rate of interest and being either repayable within a specified period or on a specified date or irredeemable during the existence of the company.

According to Justice White, “Debenture is a document which either creates a debt or acknowledges it.” Whenever a company is in need of a loan for a long period, it mostly issues debenture for the same.

Section 2(30) of the companies act 2013 lays down that ‘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.

Features of Debenture

i. A debenture is a written document issued by the company.

ii. It is a contract for the repayment of principal and its interest at a specified date and rate.

iii. A debenture is an acknowledgment of the debt by the company to its holder.

iv. The rate of interest, term, method of redemption are predetermined.

v. Interest on debentures is payable normally after six months, whether the company makes a profit or not.

vi. It is normally secured by a floating charge on the assets of the company.

vii. It can be issued at par, at a discount or at a premium.

viii. Debentures cannot be forfeited. The company can only sue the debenture holder for any balance due.

ix. A debenture is the creditors’ equity, hence it appears on the liabilities side of the balance sheet under the heading ‘long term liabilities’.

x. A company can purchase its own shares as an investment.

Kinds of Debentures

1. On the basis of Negotiability or Transferability or Record

i. Registered Debentures: – Debentures that are entered in books of the company are payable to the registered holders are called registered debentures. The interest is also payable to the registered holders. Holders cannot transfer the debenture without adopting the procedure which is led down in the law.

ii. Bearer Debenture: – Debentures which are payable to the bearer thereof are called bearer debentures. Its interest is paid to its holder they can be transferred without legal formalities.

2. On the basis of Security

i. Secured or Mortgage Debentures:– Debentures that are secured by a charge on the assets of the company are known as secured or mortgage debentures. If any default is made on the due date, the debenture holder can realise his amount from assets charged.

ii. Unsecured, simple Debenture:- Debenture which has no security on payment of principal amount and interest thereon, known as an unsecured, simple debenture. These debentures are only an acknowledgment of the indebtedness of the company under its common seal.

3. On the basis of Redemption

i. Redeemable Debentures: – the debentures which are repayable after a fixed period are known as redeemable debentures.

ii. Irredeemable Debentures: – Debentures which are not repayable during the lifetime of the company are known as irredeemable debentures.

4. On the basis of Convertibility

i. Convertible Debenture: – Such debentures wherein the debenture holders are given an option to exchange a part or whole of the debenture amount for equity shares in the company on the expiry of a specified period. Some companies issue convertible debenture wherein a part or whole of the debenture amount, after the specific period is compulsory, converted into equity shares of the company; but when the full amount of the debenture is convertible into equity shares such debentures are known as ‘Fully Convertible Debenture’.

ii. Non-convertible Debenture: – when debenture holders have no right to convert their debentures into equity shares, those debentures will be called as non-convertible debentures. Holders of such debentures have to retain the debentures, till such time as they are paid.

5. On the basis of Coupon Rate

i. Specific Coupon Rate Debentures: – when debentures are issued with a pre-determined rate of interest (coupon rate) are called specific coupon rate debentures. This rate may be fixed or floating.

ii. Zero-Coupon Rate Debentures: – These debentures do not carry a specific rate of interest. In order to compensate the investors, such debentures are issued at a substantial discount and the difference between nominal value and the issue price is treated as the amount of interest related to the duration of the debentures.^[4]