Companies issue securities to obtain financing. Equity financing is done through selling stock in the company – generally either preferred or common stock, with common stock the most popular type issued. Debt securities include bonds and debentures, which are generally fixed-income securities.
What Are Debentures?
The terms "bond" and "debenture" are often used interchangeably. Although a debenture is a bond, not all bonds are characterized as debentures. A debenture has no collateral or assets backing the debt. Instead, debentures are backed only by the creditworthiness of the issuer.
Companies are expected to repay the principal on a debenture upon maturity, and most pay interest payments during the term of the loan or the term of the bond. Therefore, debentures are synonymous with unsecured bonds. In the U.S. markets, only those businesses and entities with superb credit ratings generally offer debentures.
What Are Secured Bonds?
Secured bonds, or collateralized bonds, are issued with some form of assets backing the bonds. For example, mortgage bonds are backed by assets such as land or buildings. Equipment bonds are backed by equipment the issuer owns, such as heavy machinery or vehicles. Secured bonds generally pay interest, and at maturity, the principal or face value of the bond is repaid to the bondholder.
What Are Shares?
Shares are also sold in mutual funds and limited partnerships, but the most popular type of share is a certificate of ownership representing one equal portion of a company's capital stock. Stock shares in this form may be called "common" or "preferred."
Investors in shares of a publicly held company are the owners of the company. Shareholders are entitled to certain rights not assigned to bondholders. For example, stockholders of common shares have a right to vote for members of the board of directors and financial issues affecting the company. Shareholders are also entitled to dividends if the company's board sets forth a declaration, although there is no legal requirement to do so.
Preferred shares have characteristics similar to both bonds and common stock. A preferred stock represents equity in the company, like a common share does, and pays a fixed dividend like most corporate bonds.
Order of Precedence
Debenture investors hold claims on an issuer's assets after secured bondholders and before shareholders. In other words, should a publicly held corporation be forced to liquidate assets, they would pay secure bondholders prior to debenture investors. If assets remain after all creditors' claims have been satisfied, the shareholders are paid last, with preferred stockholders taking precedence over common stockholders in claims on the company's assets.