Before I discuss What is a Debenture in Simple Terms, I hope the term debt instrument is quite familiar to almost every investor. In short, debt instrument refers to a paper or electronics contracts that allow the issuing party to raise funds in accordance with terms of a contract. There are various types of debt instruments available in the market, such as bonds, notes, debentures, certificates mortgages, lease etc. Among them, the debenture is one of the most valuable debt instrument here.
Now, let’s define the term Debenture. It is one of the long-term debt instrument and 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 must be repaid on a specific date. Debentures are used by a company mainly to raise medium or long-term funds from the public.
What is a Debenture in Simple Terms: (Basic Features)
- 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 considered as a part of a company.
- After a certain period of time, debentures will be redeemed by payment.
- 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 considered as a 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 compare to second.
- In any 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 in 3rd position.
What is a Debenture in Simple Terms: Types of Debentures:
On the Basis of 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 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 it.
On the Basis of redeemability-
- Redeemable Debentures: When debenture is issued for a limited period of time, the company redeemed those debentures by paying the principal amount.
- Irredeemable Debentures: Debenture issued under this category cannot be redeemed till the company is winding up. This irredeemable debenture doesn’t issue in India.
On the Basis of Security–
- 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 major growth rate.
On the Basis of Convertibility–
- 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: It cannot be converted from debenture to share, that’s why it is called non-convertible debentures.
There is an example of Non-Convertable Debentures,
JM Financial Credit Solution Limited is 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 others details also regarding issue type, issue size, face value, issue price, the market lot, minimum order quantity.
What is a Debenture in Simple Terms-The Conclusion: However, the debenture is one of the most common ways of raising a company’s fund. 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 the option.