Debentures vs. Shares: Advantages of Corporate Bonds for Funding

Shares of stock represent proportional ownership in a company. Debentures are a company's unsecured debt obligations backed by the general credit of the issuer. Both securities can be used to raise capital. Depending on a company's goals, debentures may offer several advantages over issuing shares.

Avoid Dilution

When a corporation issues more stock, its current shareholder stakes may be diluted. For example, a shareholder who owns 100,000 out of 1 million shares of stock outstanding owns 10 percent of the company. If the company issues 500,000 more shares, that 100,000-share stake will shrink to 6.7 percent. Earnings per share will also shrink because they are calculated by dividing net earnings by the total number of shares outstanding. As debt securities, debentures do not cause dilution, although they might negatively impact earnings per share because of the added interest expense.

Preserve Current Corporate Structure

A corporation can issue new stock when it can find buyers for it. If the current shareholders are not able or willing to buy more stock, new shareholders will come on board and change the current ownership structure. As debt securities, debentures do not represent ownership in a company and do not affect the current ownership structure.

Temporary Financing

Stocks are perpetual securities: once a corporation issues shares, it is under no obligation to redeem them. A shareholder must find a buyer if he wants to dispose of his stake. When a company issues new shares, it shares the ownership with new shareholders forever. Debentures are issued for a limited time and repaid in full. A corporation can raise capital through debentures when it needs the money and pay it back when it has a fund surplus.

Cost Management

A debenture has a maturity date when it must be repaid in full and a call date when it can be redeemed, or called, by the issuer prior to maturity. The issuer must pay interest on the debenture but if it can find cheaper financing elsewhere, it can call the debenture and issue a new security at a lower cost.