Difference between Debenture and Shares

The upcoming discussion will update you about the difference between Debenture and Shares.

(i) Creditor ship Security v. Ownership Security:

Whereas a debenture is a creditor ship security, a share is an ownership security. It means that a debenture-holder is a creditor of the company, while a shareholder is a part-owner of the company. It is the fundamental distinction between a debenture and a share.

(ii) Certainty of Return:

A debenture-holder is certain of return on his investment. The company has to pay interest on debentures at the fixed rate agreed upon at the time of issue even if it suffers heavy losses. A shareholder cannot get dividends if the company does not earn profits.

As a matter of fact, even when a company earns a profit, its Directors may decide to plough back the profits and not declare a dividend. Thus, there is no certainty of return on investment in shares.

(iii) Order of Repayment on Winding up:

In case of winding up of a company, the amount of debentures will be repaid before any amount is paid to shareholders to return share capital.

(iv) Restrictions on Issue at a Discount:

There are no restrictions on issue of debentures at a discount, but there are legal conditions which have to be fulfilled to issue shares at a discount.

(v) Mortgage:

There can be mortgage debentures. It means that assets of the company can be mortgaged in favour of debenture-holders by way of security. But there can be no mortgage shares.

(vi) Convertibility:

Debentures which can be converted into shares at the option of debenture- holders can be issued. But shares convertible into debentures cannot be issued.

Classes of Debentures:

Debentures may be classified into different categories from different points of view:

(a) Redemption:

From the point of view of redemption, debentures can be classified as:

(i) Redeemable and

(ii) Irredeemable.

Redeemable debentures are those that will be repaid by the company within or at the end of the specified period. Irredeemable debentures are those that are repayable only at the time of winding up of the company. Debentures are invariably, redeemable.

(b) Security:

From the point of view of security, debentures can be classified into:

(i) Mortgage debentures and

(ii) Naked or simple debentures.

Mortgage debentures are those that are secured. A mortgage deed is signed by the company and the representatives or trustees of the debenture-holders whereby a charge is created on the assets of the company in favour of the debenture-holders.

The charge may be on particular assets in which case it will be called a fixed charge or it may be a charge on all the free assets of the company in which case it will be called a general charge. Simple or naked debentures are those that carry no security in which case, debenture-holders have the position of unsecured creditors of the company.

(c) Record:

From the point of view of record, debentures may be classified as:

(i) Registered debentures and

(ii) Bearer debentures.

In the case of registered debentures, the company maintains a register of debenture-holders in which a record of the names, addresses and holdings of all the debenture-holders is maintained. Transfer of registered debentures requires a transfer deed which has to be lodged with the company for the necessary changes to the recorded in the register of debenture-holders.

On the other hand, bearer debentures are transferable by mere delivery because the company keeps no record of their holders. Payment of interest is made on the production of coupons attached to the debentures.

(d) Priority:

From the point of view of priority in the payment of interest and repayment of the principal amount, there may be different series of debentures which may be termed as:

(i) First debentures and

(ii) Second debentures etc.

The debentures which have to be repaid and on which interest has to be paid in preference to other debentures are known as first debentures. The debentures which will be paid and on which interest will be paid after the first debentures have been dealt with are known as Second Debentures.

(e) Convertibility:

Debentures may be:

(i) Convertible or

(ii) Non-convertible.

Convertible debentures are those debentures which are convertible into shares at the option of the debenture holders according to the terms of the issue. Non-convertible debentures do not confer any such right on the debenture-holders and hence cannot be converted into shares.