What Are Debentures ?
Debentures are a type of long term debt instrument issued by companies & governments to raise capital.
In the share market, debentures and shares are similar words but debts and shares play the most important role in raising money for company growth and expansion. Generally, if you want to run and expand your company, you need funds. Most companies raise capital through shares and debentures.
Hence, corporations and governments also use debentures as a medium to raise capital.
A type of long term debenture has no collateral backing, mostly depending on the creditworthiness and reputation of the issuer.
Key Points :
- Debentures are loan instruments issued for medium to long-term loans.
- Debentures give you fixed interest returns on the principal amount.
- The corporation and government-issued debentures to raise capital.
- Some convertible debentures are converted into equity, while others can’t.
- Issuers repay the principal and interest at the end of the maturity period to debentures.
- The company issues a debentures certificate to the debentures holder.
Some Important Features Of Debentures :
- Borrowed fund : “Debentures are part of borrowed fund capital, as debenture holders are considered as the creditors of the company.”
- Fixed maturity date : “Debentures are redeemed after a fixed period.”
- Fixed-rate of interest : “Interest on debentures is paid at a fixed rate of interest. Often, in the annual general meeting of the company, the rate of interest is decided.”
- Security : “Most of the time, debentures are issued against some fixed assets of the company.”
- No voting rights : “Debenture holders never granted voting rights in the company.”
- Conversion : “However, some debentures are converted into shares and while others can’t.”
Example Of A Debentures :
For example, If the company Star issues debentures of ₹20,00,000, redeemable with a maturity date of 30 January 2025. This is the date on which the company will be repaid. It bears 5% interest annually, ₹1,00,000 payable on 31 July every year. An investor agrees to offer the loan at a fixed charge. If Star defaults on the payment, the investor may sell the company’s assets to raise the capital needed to fulfil the loan.
Types Of Debentures :
Based on Records :
1. Registered debentures :
- Registered in the company’s accounts with the name of the debentures holder.
- Registered debentures can’t be sold off without the permission of the Board of directors.
2. Unregistered debentures / Berar :
- Name of Debentures holders, not Registered Debentures certificate and not in company’s account.
- Whoever holds the debenture certificate becomes the owner of the certificate, and can sell debentures without any permissions.
On Basis Of Redemption :
- Redeemable debentures :
- These debentures are issued for fixed maturity periods And time.
- Issuers also Redeem at maturity date and are obligated to repurchase them from debenture holders.
2. Irredeemable debentures :
- Irredeemable debenture does not have a fixed maturity date and time.
- The issuer is not obliged to repurchase them.
- These types of debentures are issued in India.
Based on Security :
- Secured debentures :
- During the time of issuing these types of debentures company Mortgages assets to the debenture Holder as security for their amount. On the other hand, If a company fails to pay debenture holders money.
- Then, debenture holders have the right to sell the assets to recover their money.
2. Unsecured debentures :
- Generally, companies issue these Debentures without any security And the public gives money. Based on goodwill of the company and trust bases. By looking at their growth expansion and profits.
Based on Convertibility :
1. Convertible Debentures :
- These debentures can be convertible into shares and it is decided at the time of issue of the debenture how many shares Will allot in exchange for one debenture.
2. Non – Convertible Debentures :
- Technically, in these debentures, they can’t convert into shares.
- Its fixed-income instruments are generally used for long-term capital appreciation.
Difference between Debentures and Shares :
However, most companies use shares and debentures as financial instruments to raise capital from the public. Let’s learn the differences between shares and debentures.
1. Definitions –
- Debentures : Debentures are represented by borrowed capital of the company. Debenture holders are known as creditors of the company. Hence, it’s a document acknowledging the debt of the company.
- Shares : Shares represent part of ownership in the company. Often, it is just a unit of the capital.
Shareholders are members of the company and they have the right to vote. This means equity share represents ownership of the company.
- Ownership :
- Debentures Debenture holders are creditors of the company. They are creditorship securities.
- Shares : Share represents ownership of the company.
- Voting Rights :
- Debentures: The debenture holders do not enjoy voting rights as they are creditors.
- Shares : The shareholders have voting rights in the annual general meeting of the company.
- Return on investment :
- Debentures : Debentures holders are entitled to a fixed interest rate which the company must pay whether or not there are profits.
- Shares : A shareholder is entitled to receive a dividend when there are profits. The rate of dividend is various from time to time depending upon profits.
- Conversations :
- Debentures : Generally, Convertible debentures are Unsecured loans. This type of debentures are usually issued for a long term by the company & also that can be converted into shares after a specified period.
- Shares : Technically, equity or shares cannot be converted into debentures.
- Payment Security :
- Debentures : The debenture holders are entitled to paid fixed interest.
- Shares : However, after a Distribution profits a company can be paid a dividend to shareholders .
- Additional Benefits :
- Debentures : A debenture holder has no such claims on the accumulated profits of the company.
- Shares : A shareholder has a claim on the accumulated profits Of the company and normally Rewarded with bonus shares.
Difference between Debentures and Bonds :
Debentures and bonds are debt instruments issued by companies to raise funds. Let’s Know the difference between debentures and bonds.
- Definitions :
- Debentures:
Debentures are debt instruments issued by a company to raise capital.
Debenture holders are known as creditors of the company. - Bonds : Mostly, the bond is the common type of debt instrument issued by the government and corporations. It also represents an agreement to repay the principal amount with interest.
- Ownership :
- Debentures : Whoever owns the debentures certificate is called a debenture holder.
- Bonds : The bond owners are called bondholders.
It’s issued By the Government & corporations.
- Returns On Investments :
- Debentures : After the Specific period later debentures holders are paid fixed interest on the principal amount.
- Bonds : Whereas Bonds give you lower interest than debentures. In the investment world bonds are Known as safe investments.
4. Tenures :
- Debentures : Debentures are medium to long-term investments & Often have a shorter tenor than bonds.
- Bonds : Bonds are Long term investments, mostly they have a higher tenor than debentures.
Pros and Cons of Debentures :
Debentures are the common long-term debt instrument issued by companies to raise capital. Mostly the company issued debentures for expansion or to run new operations and growth of the company.
Investment in debentures provides some pros :
- Security: Debentures are usually secured by fixed or floating charges.
- Returns: A fixed rate of interest is paid on debentures.
- Tax: Debenture holders get a tax advantage in respect of interest.
- Liquidity: Mostly Debentures are sold out in the secondary market & it offers liquidity to investors.
- Paid off first: Debentures holders are paid off first Because of Their liability to the business.
Debentures also come with certain cons :
- Market risk: Be Aware of price fluctuations and depending on market Momentum.
- Right to vote: Debenture holders can not have the right to vote in the company.
- Interference: Debenture holders did not interfere in company management.
- Returns: Debentures Are more secure than stocks, but technically it will lead to lower returns
Conclusion :
In conclusion, Debtentures are long-term debt instruments issued to raise capital by a company to grow and expand its business. Convertible debentures are after a periodic time later it will convert into equity, giving you good returns. all debentures are not convertible while others are different. Before investing, It’s very important to understand the risks and rewards involved.