Debentures are a popular investment tool among stock market investors. In this post, we will discuss “What is a Debenture”. And we will also discuss different types of debentures. But before that let us first discuss a debt instrument.
Introduction to Debt Instruments
I hope the term debt instrument is quite familiar to almost every investor. In short, a debt instrument refers to a paper or electronic contract that allows the issuing party to raise funds in accordance with the terms of a contract. There are various types of debt instruments available in the market, such as bonds, notes, debentures, certificates mortgages, leases, etc. Among them, the debenture is one of the most valuable debt instruments here.
What is a Debenture?
Now, let’s define the term Debenture. It is one of the long-term debt instruments and is generally not secured by specific property or collateral. So, if a company requires funds for extension and development but doesn’t want to raise its share capital, it can issue debentures. Unlike shares, debentures are for a fixed period of time with fixed interest rates. Typically, it’s a loan, but borrowers must repay it on a specific date. Debentures are used by a company mainly to raise medium or long-term funds from the public.
Features of a Debenture
- Just like the loan, debenture holders are the creditors of a company carrying a fixed rate of interest.
- As debenture holders are the creditors, they are not part of the company.
- After a certain period of time, the investors can redeem the debentures or they can take the payments.
- The interest rate of debenture doesn’t depend on the profitability or loss of a company because of the fixed interest rate.
- A company can minimize its tax rate by showing debenture interest.
- As the debenture holders are not part of a company, they do not enjoy voting right like shareholders.
- Investors can sell debentures in two ways. They can find the buyers by themselves or their brokers may find the buyer but the first option is quite costly and time-consuming in comparison to the second.
- In many circumstances, if a company will be winding up, debenture holders get the first preference of getting their money, preference shareholders come at 2nd and general shareholders come into 3rd position.
Types of Debentures:
Transferability and Records
- Registered Debentures: Registered debenture holders’ profile details are registered in a company’s registration. Investors can’t transfer it directly, they have to sanction from the company’s director.
- Bearer Debentures: There is no registration of debenture holders in a company. Their name doesn’t register in the company data. Those who have certificates are the holders of them.
- Redeemable Debentures: When a debenture is issued for a limited period of time, the company redeemed those debentures by paying the principal amount.
- Irredeemable Debentures: Debentures issued under this category cannot be redeemed until the company is winding up. This irredeemable debenture doesn’t issue in India.
- Secured Debentures: This type indicates debentures with proper security so that if the company is winding up investors can recover their money.
- Unsecured Debentures: This debenture is issued without security. Generally, investors choose unsecured debentures of a company with high profitability and a major growth rate.
- Convertible Debentures: The debentures which can be converted into shares, are called convertible debentures. The advantage of a convertible debenture is sometimes investors agree to buy this debenture even at low-interest rates. The convertible figure is pre-decided.
- Non-Convertable Debentures: They cannot be converted from debenture to share, that’s why it is called non-convertible debentures.
Example of Non-Convertable Debentures
JM Financial Credit Solution Limited a non-banking financial company, is going to issue NCD (Non-Convertable Debentures) soon. The issue details are as follows:
The issue is going to open on May 28, 2018, and close on June 20, 2018. There are other details also regarding issue type, issue size, face value, issue price, the market lot, and minimum order quantity.
A debenture is a form of debt that provides an investor with a fixed rate of return from the issuing company. We also know it as loan stock or bonded loans.
For example, if Company A issues 10% Debentures worth INR 100 crore, it means Company A has raised Money by pledging its assets and agreeing to pay annual interest at 10%.
There are two main types of Debentures – Secured and Unsecured Debentures. In secured Debednture, the issuer must create a charge on specific assets as collateral against defaulted payments. An unsecured one relies solely on creditworthiness and reputation for repayment.
The main difference between these two investments lies in their ownership structure. Loans are paid back directly to lenders, whereas funders who buy debentures become part-owners in the business they’ve invested in. Furthermore, companies need to repay back loans within certain set timescales, while companies can choose when they wish to repay their debts through redeemable (or non-redeemable) debt instruments such as bonds or perpetual bonds.
However, the debenture is one of the most common ways of raising a company’s funds. One of the main advantages of a company is debenture interest is a tax-deductible expenditure, so it saves income tax. Investors can go for investing in them to diversify their portfolios.