Different Types of Debentures Explained
The term ‘debenture’ is derived from the Latin word ‘debere’, which means to borrow. Debentures are the debt of a company. They include medium to long-term debt or loans that the company avails to raise capital for its operations or expansion.
The company has to repay these securities after a fixed tenure, and they have to pay a fixed rate of interest to the lender at specific intervals, usually monthly, quarterly, or annually. Companies that have raised capital through debentures pay the interest on debentures before paying dividends to their shareholders.
This article will illustrate the different kinds of debentures in detail.
Different Types of Debentures
Companies issue various types of debentures based upon their needs and objectives. The categorisation of debentures is dependent on their tenure, convertibility, redemption mode, security, coupon rate, etc. Here is a list of the most common types of debentures that the companies issue:
- Convertible debentures
When it comes to convertible debentures, the investors have a right to convert their debentures to equity shares. In most cases, the conversion rate, the rights of the people who hold the debenture, and the date of triggering the conversion are mentioned at the time of issue of debentures.
- Non Convertible debentures
In this type of debentures, the investor does not have the right to convert their debentures into equity shareholdings of the company.
- Registered debentures
In this type of debentures, the company issuing the debentures enters all the details of the holding, which include the number of debentures that have been issued, address, and name of the holder, etc., in the register maintained for debentures. In this scenario, if the debenture holder chooses to transfer his shares to other investors, the records are added to the register of debenture holders and the register for transfer of debentures.
- Unregistered debentures
These debentures are commonly known as bearer debentures. In such a scenario, the company does not keep any records. The principal amount and the amount of interest on debentures are paid to the bearer of the instrument without any consideration of whose name is written on it. The advantage of such a debenture is that the transfer of this debenture is convenient and easy.
Also Read: Difference between Shares & Debentures
- Redeemable debenture
In the case of redeemable debenture, the date of redemption of the principal amount is detailed on the debenture certificate issued by the company. On the redemption date detailed in the debenture certificate, the company is legally mandated to pay back the principal amount to the holder of the debenture.
- Irredeemable debenture
Unlike in the case of the redeemable debentures, the date of redemption of the principal amount is not fixed when it comes to irredeemable debentures. The debentures continue for an infinite time and the principal amount is returned to the holder only when the company enters into liquidation.
- Secured debentures
These debentures are secured by some assets or an asset that the debenture holder can liquidate if he requires to do so. Accordingly, the debentures are also categorised into two subcategories: first mortgaged and second mortgaged debentures.
- Unsecured debentures
Unlike secured debentures, unsecured debentures are issued by leveraging the reputation and goodwill that the company has generated. As a result, unsecured debentures are commonly known as naked debentures.
Now that you understand the kinds of debentures, it is essential to know the features, importance and uses of debentures.
Features of Debentures
Here are some important features of debentures:
- Debenture holders are the company’s creditors and have a fixed interest rate.
- Debentures are redeemable after a certain period except for irredeemable debentures that are redeemable after the liquidation of the company.
- The interest paid to debenture holders is charged against the profits of a company, so it is a tax-deductible expense.
- There are no voting rights provided to debenture holders.
Also Read: How To Download Demat Account Holding?
Advantages of Debentures
Here are some advantages of debentures:
- Issuance of debentures does not lead to dilution of ownership as they do not carry any voting rights.
- The cost of debentures is usually lower than that of equity or preference shares.
- Issuing debentures is a tax-deductible expense so it helps save on the income tax.
- The interest on debentures has to be paid even if there is a loss, so there is no risk for the investor.
Uses of Debentures
The company issues debentures to raise capital from the public. The capital raised from the debentures is used by the company for various purposes like expansion, growth, and research and development.
Many companies prefer to issue debentures over equity shares because of two main reasons. One is that issuing debt instruments does not lead to liquidation of the ownership of the company. Secondly, the cost of issuing debentures is lesser than the cost of raising capital through the issue of shares.
Thus, these are the various types of debentures that companies can issue to raise capital for expansion and growth. You can add debentures to your portfolio of investments if you think that they suit your needs and risk profile.
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Frequently Asked Questions
The different kinds of debentures issued by the company are categorised according to parameters which include mode of redemption, tenure, convertibility, security, conversion rate, etc.
Debentures are a good investment option for people who have a low risk-taking capacity. This is because they provide a fixed rate of interest to the investors, and the interest is paid even if the company has experienced a loss.
The difference between bonds and debentures is that bonds are issued when the company keeps an asset as collateral. Debentures, on the other hand, can be secured and unsecured. Bonds are less riskier for investors as they carry collateral, whereas unsecured debentures are risky as they are issued based on the reputation and goodwill of the company without any collateral.