In the ever-changing business and financial arena, organisations usually need huge amounts of money to grow, renovate, or maintain their operations. Debentures are one of the surest and oldest-established tools for raising such long-term capital.
Debentures play a significant role in bridging the gap between corporate requirements and investor opportunities. They enable firms to secure funds without watering down ownership and provide investors with a secure funding opportunity that is not risky. This article describes the essence of debentures, their main peculiarities, and the types of debt instruments issued by companies.
What is a Debenture?
A debenture is a long-term debt instrument issued by a firm to obtain funds from the public. Whenever an individual purchases a debenture, s/he are basically lending to the company. The company, in turn, commits itself to paying a certain rate of interest in regular intervals and repaying the sum of money at maturity.
Debenture holders are not owners of the company, as opposed to shareholders. Creditors are a source of credit, and thus, they lack voting rights or a share in management. However, they have a preference over shareholders in the case of liquidation repayment.
Rudely speaking, a debenture may be referred to as a loan certificate provided by a company, which is the evidence of the company that it guarantees to pay back the borrowed funds plus the interest.
Key Features of a Debenture
- Fixed Interest Rate: Debentures attract a fixed interest rate, which assures investors of a stable flow of money.
- Repayment Obligation: The company will pay back the whole amount of the debenture on the maturity date as stated in the terms of the debenture.
- No Voting Rights or Ownership: Holders of Debentures are not owners and are not allowed to vote or own any part of the company.
- Transferability: Debentures are easily transferable instruments that can be sold or purchased in the secondary market.
- Preferential treatment in Repayment: Debenture holders are given preference over shareholders in the event of liquidation.
- Security Backing: Security is supported by the assets of many companies, which increases the safety of the investor.
Types of Debentures
Debentures are categorised into groups based on various grounds, namely security, convertibility, tenure, registration, and participation. We can learn about each type individually.
1. Secured and Unsecured Debentures
Secured Debentures:
The company’s assets or property are used as security for these. Debt holders can recover their money by selling the security to recover their dues in case the company defaults on paying interest and principal. This renders secured debentures a less risky investment.
Unsecured Debentures:
These are also referred to as simple or naked debentures and they are not secured by any security. Investors will only rely on the financial capability of the company and the reputation. Due to increased risk, there is a tendency to have increased interest rates on such debentures.
2. Convertible and Non-Convertible Debentures
Convertible Debentures:
They can be converted to equity shares after a certain duration, enabling investors to become shareholders. Convertible debentures combine debt and equity and offer fixed income as well as the prospect of earning capital gains.
- Fully Convertible Debt: A hundred percent is converted to equity.
- Partly Convertible Debentures: It converts a part of it to shares, and leaves the rest as debt.
Non-Convertible Debt (NCDs):
They are not convertible into shares. Shareholders obtain a fixed rate of interest on a regular basis and repayment on maturity. Non-convertible debentures are attractive to those investors who want to receive low-risk, steady income.
3. Redeemable, Irredeemable Debentures
Redeemable Debentures:
Redeemable debentures can be repaid on a certain date or after a stipulated amount of time. The company has a legal obligation to pay the capital and interest at the time of maturity. Due to the definite terms of repayment, this is the most prevalent type in the market.
Irredeemable Debentures:
Also, perpetual debentures, as they are also called, do not have a fixed maturity date. It can redeem them at any time of the company or at the winding-up. They are uncommon nowadays, but they were very common in the past when speculators were interested in a fixed income throughout their lives.
4. Registered and Bearer Debentures
Registered Debentures:
The company register contains the name and details of the holder. Only the registered holder gets to receive interest and repayment. The conveyance of ownership must be done by the transfer of a formal transfer deed and recorded in the company.
Bearer Debentures:
Bearer debentures are not registered under any name. Delivery of the certificate is all that it takes to transfer ownership. Interest is charged to whoever offers the coupon or certificate. They can be transferred easily but it poses greater risk in case they are lost or stolen.
5. Non-Participating and Participating Debentures
Participating Debentures:
Besides fixed interest, those who hold participating debentures also receive a share of the company’s profits once the shareholders have been paid the dividends. This makes them a hybrid of security and upside in terms of debt.
Non-Participating Debentures:
These will offer fixed interest income. The shareholders do not receive a portion of the company’s excess profits.
6. First and Second Debentures
First Debentures:
They are of first priority over the company assets and therefore, they are rectified prior to the other creditors in the event of liquidation.
Second Debentures:
These follow initial debentures that follow the order of repayment. Due to the relatively increased risk, they tend to pay higher interest rates to lure investors.
Conclusion
One of the most reliable and common tools for raising long-term capital is debentures. They strike a balance between the interests of the companies and the investors, giving companies a stable source of funds and investors a constant, low-risk yield. The ability to find the kind of debentures would enable corporate managers and investors to make sound financial decisions.
Debentures are still important in contemporary financial framework as a foundation of corporate borrowing and investment policy to provide stability, transparency, and win-win results.
