There are many differences between preference shares and debentures. The biggest difference is that a preference share is an equity security that gives the owner preferential rights in the event of a dividend payment or liquidation by the underlying company, while a debenture is a debt security issued by a corporation or government entity, and it is not backed by an asset or lien.
What Are Preference Shares?
Preference shares are shares of a company's stock issued to preferential shareholders or stakeholders. Much like common stock, preference shares represent ownership in a company. Unlike common stock, preference shares normally do not carry any voting power but give the holder of the preference shares claim on a specific quarterly dividend amount and precedence over common stock in the event of a company liquidation.
There are four types of preference shares:
Preference shares are an optimal alternative for risk-averse equity investors. They are typically less volatile than common shares and offer investors a steadier flow of dividends.
What Are Debentures?
Debentures are a corporate or government bond not secured by any specific assets or property. This means a debenture is riskier than a secured debt instrument but garners a higher interest rate payment to offset the risk. In the event of a liquidation, the holder of a debenture bond is viewed as a general creditor and must wait to be repaid until all the secured creditors have been repaid.
There are two types of debentures:
- Convertible debentures
- Non-convertible debentures
All debentures have specific features. First, a trust indenture is drafted, which is an agreement between the issuing corporation and the trust that manages the interest of the investors. Next, the coupon rate is decided, which is the rate of interest that the company will pay the debenture holder or investor. This rate can be either fixed or floating and depends on the company's credit rating or the bond's credit rating.
Preference Shares vs. Debentures
The main difference between preference shares and debentures is the former is an equity security giving its owner preferential rights, while the latter is a debt instrument that gives its owner fewer rights but a higher interest rate to offset the risk. The secondary difference is preference shares protect the holder in the event of a liquidation, while debentures do the opposite of protecting the holder.