Why Share and Debenture?

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Share and Debenture

The most important source of long-term finance for limited companies is through the issue of shares and debentures.

Shares

Holders of share own the company. A public limited company is allowed to sell its shares to the general public by issuing a prospectus. After wards, its second –hand ‘shares are traded on the stock exchange. A private limited company must sell its shares privately: these cannot be bought and sold on the stock exchange.

Ordinary share allow their holders a vote at company meetings. The rate of dividend (payment of profits made to the shareholders) depends on the amount of profits: it is a variable rate. Ordinary shareholders are the last to be paid out of profit: it is a variable rate. Ordinary shareholders are the last to be paid out of profit and so they face the risk of not receiving any dividend if profits are low. They are also the last to have their capital repaid if the company is ‘wound up.’

Preference shares do not normally give the right to vote. These shareholders receive priority over ordinary shareholders for paying dividend and repaying capital. The preference dividend is fixed. Some preference shares are cumulative: if profits in one year are too low to pay the dividend, the amount owing is carried forward to future years and will be paid when future profits are high enough.

Ordinary and preference shares

Particular	ordinary	Preference
Voting rights?	Normally one vote per share	Usually non-voting
Dividend payment?	Variable (high or low depending on profits)	Fixed , regardless of profit level
Capital repaid?	Paid after preference ; repaid last	Paid before ordinary ; repaid before ordinary

 

Some small and growing companies that want to fiancé future expansion, but cannot issue more shares or raise the finance by other means, use venture capital (vc). This is also known as private equity and is provided by specialist vc businesses in return for a proportion of company’s shares. The vc business often requires a say in decision-making by having a representative on the borrowing company’s board of directors.

Debentures:

Debentures are long –term loans (often called ‘loan stock). The debenture holders are creditors of the company, not the owners (unlike shareholders). The loan will normally be secured against the assets of the company: if the company cannot repay the loan, the debenture holder has 

the right to sell the assets to recover the debt owed. In return for this loan the debenture holder receives interest, which must be paid by the company whether it making a profit or is a loss. Like other loans, a debenture loan will be repaid in the future.

Shareholders and debenture holders

Particular	Shareholders	Debenture holders
Status?	Owners of the company	Lenders to the company
Reward?	Dividend , paid out of business expense	Interest , paid whether or not the company makes a profit
Repayment?	Not normally repaid , unless the company is wound up	Normally repayable at a future date: if company is wound up repaid before shareholders.