A GIST on Debentures and Types of Debentures

Companies and governments use debentures as a debt instrument for issuing loans. This will be issued on the basis of the credibility of the companies at a fixed rate of interest. So, we can say that this is a bond or is an instrument which is used for raising funds from the public at a fixed rate of interest for its expansion or such other functions.

Advantages:

Investors can easily opt an investment option with lower risk and a fixed income providing one,
The debenture holders does not get the voting rights, due to which there will not be any dilution of control with respect to the equity shareholders,
The profits earned by company does not get affected by the interest payment to the debenture holders,
These instruments can be easily adopted by the company when sales and earnings are stable on a relative basis,
The cost related to the debenture instrument is less, as the interest paid to them are tax deductible.

Disadvantages

The interest on debenture instruments are to be paid on a regular basis which creates a risk when there is major fluctuation with respect to the earnings of the company.
The debentures reduce the borrowing capacity of the company as this again is a cost addition.
In case of the debentures which are redeemable after a fixed period, the company will have to repay the same despite of any financial constraints of the company.

Types of Debentures

There are various types of debentures like:

Secured and Unsecured Debentures,
Registered and Bearer Debentures,
Convertible and Non-Convertible Debentures,
First and Second Debentures.

The above stipulated types of debentures are explained below in detail for a clear understanding:

Secured and Unsecured Debentures:

In secured debentures, the same creates a charge on the assets of the company which creates a mortgage on the assets of the company. The charges created for this can be either fixed or floating. In case the charge is fixed, the assets of the company can only be sold with the permission of the debenture holders. While in case of the floating charges, the company is free to deal with the assets at their discretion and need not seek permission from the debenture holders. But as and when the debenture holders exercise controls the charges will get crystallized and the company would then not be allowed to deal with such assets.
The unsecured debentures do not carry any charge on the assets of the company. The company will not provide any assets for such debenture holders with respect to the payment of the principal or interest pertaining to such assets. They are in fact treated as unsecured creditors and are also known as naked debentures.

Registered and Bearer Debentures:

A registered debenture is the one which would be entered in the register of debenture holders of the company. For the transfer of the same, a regular instrument of transfer shall be required.
While in case of the bearer debentures, the same is transferable by mere delivery. No records will be maintained with respect to such debentures and no details pertaining to the ownership of such debentures will be maintained. They shall be issued in paper or in a physical form. And such debenture holder shall submit the coupon attached to the paper for receipt of interest payments.

Convertible and Non-Convertible Debentures:

Convertible debentures are the ones which can be converted into equity shares after the expiry of a period. The rate of interest is lower compared to the non-convertible debentures. And the maturity value of this depends on the company’s stock price at the time of issuing the debenture.
While the non-convertible debentures are the one’s which cannot be converted into equity shares. But in this the rate of interest are higher. And the maturity value of such debentures remains fixed, and they give fixed returns on maturity.

First and Second Debentures:

A debenture which would be repaid prior to the other debentures of the company are known as first debentures. This is having the first charge over the assets of the company.
While the second debentures are the ones which would be paid back only after the repayment of the first debentures. This will be having only second charge, which basically means that realization of the assets will first fulfil first mortgage debentures and then only will be utilized for repaying the second debentures.

Redeemable and Irredeemable Debentures:

Redeemable debentures are repayable in lumpsum at the end of a pre-fixed or specified period or also in instalments during the period. This debenture can be redeemed by annual drawings or by purchasing from the open market.
While irredeemable debentures, cannot be redeemed by the debenture holders after a specified period of time. This will not be redeemed in the life time of the company and would only be paid back when company goes into liquidation.
So, we can conclude that debentures are one instrument which can be issued by the company for raising fund and one which can be chosen by the investors easily as the risk involved is low along with ensuring a fixed return in the form of interest.