Meaning of Debentures

Debentures are the debt of a company. In simpler terms, one can call them loans or debts that different companies avail themselves of with the motive of raising capital. In terms of validity, they can range from medium to long-term. After a specific interval (annual, quarterly, or monthly), the holder also receives a fixed interest rate from the company. In most cases, the company pays off the debenture interest before paying the dividends. Thus, we see that when there is a need for borrowing money for expansion, the companies make use of debentures. Now, let’s learn more about debentures, their types, and their pros and cons.

Define Debentures

The term debenture has its origin in the Latin word ‘debere’. The meaning of ‘debere’ is to borrow. It is an instrument that a lender, like a bank, uses for offering capital to a company or individual. As a result, the lender is able to secure loan repayments against the assets of the borrower. Thus, a debenture is a bond that a company issues under its seal.

How Do Debentures Work?

The borrower will issue a debenture through an agreement. This agreement is known as an indenture. The agreement will depend on the country of the issue as it will outline the particular details like the loan’s amount, maturity date, convertibility, and interest rate. For instance, The Companies Act, 2013, will apply to debentures in India. Once this is in place, the investor will lend the funds to the borrower. Finally, the lender will expect repayment at the interest rate agreed between the two parties.

Features of Debentures

• Acts as instruments of debt
• Allows debenture holders to become the company’s creditors
• Certificate of debt containing the redemption date and the repayment amount is provided
• Comes with a fixed rate of interest
• Does not give any voting rights to debenture holders
• Payments are mandatory even if there are losses

Advantages of Debentures

• Debentures are usually preferred for raising funds when there is inflation as they offer a fixed rate of interest.
• The interest that gets paid on debentures is basically a charge against the company’s profit, thus, making it a tax-deductible expense. Consequently, it is beneficial when planning taxes.
• They promote long-term planning plus funding. Moreover, in comparison to other forms of lending, they are cheaper.
• It allows companies to acquire the required funds without having to dilute the equity. As debentures are in debt form, the company’s equity will not change.
• The risk for debenture holders is minimal because it is a secured loan with payable interest even if the company suffers a loss.

Disadvantages of Debentures

• When the debentures are redeemed, there is a monumental cash outflow that can result in the imbalance of the company’s liquidity.
• They make the company dependent on debt. If the Debt-Equity ratio of the company gets skewed, the company’s financial health suffers.
• They can become very expensive during times of depression because of their fixed interest rate.
• The interest to be paid to the holders acts as the company’s financial burden because they have to pay it regardless of profit or loss.

Types of Debentures

A company issues different types of debentures. They are usually based on the objectives and requirements of the company. 

Secured Debentures and Unsecured Debentures

In secured debentures, the charge is generated on the assets or properties of the company. The charge can be fixed or floating. In unsecured debentures, there is no specific charge on the company’s assets. But, there can be floating charges on these kinds by default.

Registered Debentures and Unregistered Debentures

Registered debentures are based on record. In these kinds, the debenture holder’s details, such as an address, name, particulars of holding, etc., are filed in a register. The company keeps this file, and these debentures move only when a normal transfer deed is performed. Unregistered debentures are the opposite of registered debentures, as there is no record of the debenture holder’s information with the company. Moreover, they can be transferred easily in the market.

Convertible Debentures and Non-Convertible Debentures

Convertible debentures are changeable debentures in which the investors can convert their debenture holdings into the company’s equity shares. Usually, at the time when the debentures are issued, the rights of the debenture holders, rate of conversion, and the conversion’s trigger date are defined. Non-convertible debentures do not have the option of changing into equity shares or any other security, for that matter. Most of the debentures that companies circulate fall under this class.

Redeemable Debentures and Irredeemable Debentures

A redeemable debenture is owed on the expiry of the time frame. It can either be in instalments or a lump sum for the duration of the company’s lifetime. Moreover, one can reclaim these debentures at par or even at a premium. In irredeemable debentures, the company does not provide any opportunity to repay the borrowed or acquired money when such debentures are circulated. They can be repaid on the company’s closing up or on an extended period’s expiry.

Conclusion

Debentures are debt instruments that are most commonly used. The company issues them for raising funds for their business. Thus, it is a bond that the company issues under its seal. This is like an acknowledgement of the debt and comprises provisions regarding the repayment, principal, and interest. There are different types of debentures based on various factors such as security, tenure, convertibility, coupon rate, etc. In India, debentures fall under The Companies Act, 2013.