What are Company Debentures?
When it comes to corporate finance, company debentures are loan instruments for medium to a long term of period. These are offered by both large companies and the government. Debentures mainly work on the reputation of the issuing authorities and at a fixed interest rate. Authority bodies issue debentures when they seek to borrow money from the public at a predetermined rate of interest.
Types of Debentures
There are several types of debentures available in the market.
- Secured debentures
When company debentures are secured against assets of the concerned company, these are called secured or mortgage debenture.
If the security is on assets of the issuing company, then it is called fixed charge debentures. Contrarily, if the security is not specific but generic assets of the organisation, it is called a floating charge debenture.
Secured debentures examples are such as company or factory building. If the company gets insolvent, the loan amount needs to be cleared before selling the property. These are divided into two further categories –
- First mortgage or preferred debenture
First mortgages or preferred debentures’ obligations are justified first with preference in time of realisation of the assets.
- Second mortgage or ordinary debenture
After fulfilling the first mortgage debentures debt, second mortgage or ordinary company debentures will be serviced in the event of realisation.
- Unsecured debentures
Unsecured debentures are created only out of the credibility of the company, and they don’t carry securities against any assets of the concerned company. Therefore, the relevant organisation doesn’t offer any protection on the rate of paying interest or on paying off the loan amount to the holders.
- Convertible debentures
Convertible debentures are mixed financial tools carrying the benefits of both debt and equity shares. Individuals who hold company debentures like convertible debenture are allowed to convert their assets into stocks. This conversion will be done with a specific ratio and after a certain period depending on the terms and conditions of the contract.
Furthermore, convertible debentures have two types – partly convertible and fully convertible. As the name suggests, fully convertible debentures are allowed to be converted entirely into equities. However, with party convertibles, only a limited part can be converted into stocks as per the norms of the contract.
Here is a convertible debenture example –
A company authorises convertible debentures with a 15:1 rate, and the conversion can be done after 2 years. Now, after 2 years, the stock price of the company goes up from Rs. 40 to Rs. 100.
Now, the convertible debenture holders can convert their debenture into stock at the ratio of 15:1. Here, one debenture will convert into the stock worth of Rs. 100 X 15 = Rs. 1500.
- Non-convertible debentures
Debentures that don’t allow the holders to opt for the conversation of debt to stock are called non-convertible debentures. This type of debenture endures as debt only.
- Redeemable debentures
If the company debentures issuing authorities are legally mandated to redeem the debenture certificate on a particular date and pay the return to the investors, then those are called redeemable debentures.
- Irredeemable debentures
Contrary to the previous one, irredeemable debentures don’t carry along a redemption date with it. Therefore, these debentures can be redeemed either when the company will liquefy its assets or as per the terms and condition of the debenture contract. Another name of these debt instruments is a perpetual debenture. In the Indian security market, this type of debenture is not allowed to be sold.
- Registered debentures
Registered debentures are those debt tools where the credentials of the holders such as their name, bank details, residential address, etc. are legally enrolled with the issuing authority. Hence, the investors must notify the organisation if the company debentures have already been transferred to another individual. Or else, the accumulated return will be credited to the previous holder.
- Bearer debenture
Differently, bearer debentures don’t carry any registration with any specific investor’s details. With a mere delivery process, the debentures are transferred to any new holders. Moreover, the accumulated interest is paid at the exchange of coupon attached to the debenture certificate.
Features of Debentures
As an investment avenue, debentures carry some lucrative features. Few features of debenture include –
- As the return is determined with a fixed rate of income and the investment is secured with the charge of the company’s assets, this is a preferred investment option. Fixed return at lower risk is the preferred investment avenue for all.
- Holding company debentures don’t imply any ownership of the company. Therefore, debenture holders don’t possess the right to vote or control the management of the issuing authority. Yet, in case of default return, they can avail legal steps against the organisation.
- With a higher face value, debentures come with a better return than share investment.
- In the event of liquefying the company, debenture holders get preferences in terms of repaying the borrowing amount.
- Irrespective of having profit or loss, the concerned company is bound to return the obligations at a predetermined rate of interest to the debenture holders.
Differences between Shares and Debentures
Even though both debenture shares can raise capital for a company, they are different from each other in every other aspect.
Here are some differences between them in a nutshell –
|Definition||Company debentures are the loan contract by that company borrow fund from the public.||The fund raised by share selling is the company’s assets.|
|Status of the holders||Investors who buy debentures from a company are entitled as debenture holders, and they are creditors to the company.||Individuals who own shares of a company are determined as shareholders, and they are owners of the concerned organisation.|
|Payment security||Debenture carries security on return.||Shares don’t carry any security on return.|
|Return||Companies repay the borrowings at a fixed rate of interest to the debenture holders.||Shareholders get a return by dividend payment.|
|Operation method||In case of debentures, the holders get interest regardless of the profit of the company.||Shareholders’ payments are made from the profit earned by the concerned company.|
|Controlling rights||Company debenture holders are not allowed to vote or control the management.||As owners, shareholders carry the power to vote and control the management to some extent.|
|Conversion option||Debentures can be converted into shares.||Shares don’t carry the option to be converted into debentures.|
|Trust deed||At the time of issuing debentures, a trust deed is mandated to be circulated as well. This is to protect the investment as there is no collateral against the loan.||Shares don’t carry any trust deed.|
Often, debenture and debenture stocks are treated similarly. However, they are not similar. Companies and government bodies issue debt instruments or securities to accumulate funds at times via debentures.
On the other hand, debenture stocks are loan contracts between a company and the holders. Here, the holders are paid dividends from the profit earned by the company, at predetermined intervals.
As per the operation of debenture stock, it works similar to the way preferred stocks operate. Also, when it comes to the risk factor of an investment, debenture stocks carry a similar risk of any other kind of equities. However, these are backed by the trust deed. Hence, the trust acts as a protector to the shareholders. And, the stockholders can appoint receivers who will help them to realise the assets to keep the holder’s money safe.
To sum up, debentures are safe investment avenues where the money will be protected. Also, the return is determined at a fixed rate of interest regardless of the loss and profit of the issuing company. Furthermore, in the event of realisation of the assets of the concerned organisation, debentures holders are preferred to receive the return. However, issuing company debentures regularly can lead the company to disable the balance sheet, which leads to the company gradually losing its creditworthiness.
Q1. Why do companies issue debentures?
Ans. Issuing company shares means it is sharing its ownership with other individuals. Contrarily, companies issue debentures to raise the capital in need for a limited period. This is commonly called public borrowing. At times, companies will repay the debenture holders along with interest returns whenever the company acquires substantial surplus.
Q2. Who are the debenture holders?
Ans. Individuals who pay the company to purchase debentures are called debenture holders. Unlike shareholders, debenture holders only lend loans to the company for a specified period.
Q3. How do debentures work?
Ans. A debenture is a contract between the investor and the company, where a charge over the company’s assets is granted to the lenders by providing them security on their investment.