Shares: An overview

In the last post, some common terms related to shares were discussed.  Now, we would get an overview of some common types of shares and differences between shares and debentures.

Shares: As mentioned in the previous post, a share represents a faction of an individual’s ownership in the company. For example, if the equity share capital of a company is Rs 500000, and it is divided into 5000 shares, the value of one share is Rs500000/Rs 5000 = Rs100. Thus, an individual holding 1000 shares has a 25% ownership in the company.

Equity shares and Preference shares are the two most common types of shares. The primary difference between equity shares and preference shares is that in the latter case the shareholders are entitled to receive  a fixed rate of dividend which is to be paid before dividend can be paid in respect of equity shares. Another important difference is that the preference shareholders enjoy priority over the equity shareholders in payment of surplus and on liquidation of the company. There are several types of preference shares, two of the most common ones are:

·        Cumulative preference shares: In this case the accrued dividend keeps on accumulating till paid.

·        Convertible preference shares: Here the preference shares are converted to equity shares after a stipulated time period or after certain conditions are fulfilled.

Rights Shares: These are those shares that are issued to existing shareholders at a certain price in proportion to the shares held by them. For example, if a company comes up with a rights issue in the ratio of 1:5, each shareholder who currently has five shares is offered one share at a definite price. The shareholder is free to accept or reject the offer.

A rights issue should not be confused with a bonus issue. In the latter case, the shares are distributed in a particular ratio among the existing shareholders free of cost. The issue of bonus shares does not bring money into the company, whereas an issue of rights shares does.

Debentures: A debenture is a certificate of acknowledgement of debt. When a company issues debentures, it raises money in the form of loan, and hence the debenture holders are creditors to the company. Debenture holders are entitled to receive a fixed rate of interest, irrespective of the profit or loss of the company. Convertible debentures are the most common types of debentures. Here, the debentures are convertible to shares after a stipulated time period or after fulfilling certain conditions.

Difference between shares and debentures

The shareholders of a company are owners of the company, whereas the debenture holders are creditors of the company. The dividend payable to shareholders varies with profit (in most cases, when there is no profit, no dividend is paid). On the other hand, a fixed rate of interest is payable to the debenture holders irrespective of the profit or loss. Debenture holders are exposed to less risks as compared to the shareholders because in the former case, the income is regular in nature. It should be noted that at the time of liquidation of the company, the claims of the debenture holders are settled before the claims of the preference and equity shareholders.

In the next post, the basics of stock exchanges and trading would be taken up. I request the readers to come up with questions, comments and suggestions.

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