Different types of debentures and their use

Generally, the companies pay the debenture interest before paying the dividends.

Jul 01, 2021 11:07 IST India Infoline News Service

The term 'Debenture' comes from the Latin word, 'debere,' which literally translates to borrow. Debentures are essentially a company's debt. They are medium to a long-term loan or debt availed by the companies to raise capital. These securities are repayable after a fixed period, and the companies pay the holder a fixed interest rate at a specific interval, usually monthly, quarterly, or annually. Generally, the companies pay the debenture interest before paying the dividends.

Types of Debentures

A company can issue different types of debentures based on their objective and requirements. And, the debenture categorisation depends on redemption mode, tenure, convertibility, security, tenure, coupon rate, etc. Let us look at some of the most common types of debentures issued by companies.

● Convertible debenture

These are a type of debentures where the investors have the right to convert their debenture holdings into equity shares of the company. Generally, the rights of the debenture holders, the conversion rate, and the trigger date for conversion are defined at the time of issuing the debentures.

● Non-convertible debenture

The debentures which do not have the option to be converted into equity shares are non-convertible debentures.

● Registered debenture

In the case of registered debenture, the company that issues the debenture enters the holding details, including the number of debentures issued, name and address of the investor, in the register of debentures. In such cases, if the debenture holder transfers their holdings to other investors, the details are recorded in the register of debenture holders and the register of transfer.

● Unregistered debenture

The unregistered debentures are also commonly referred to as bearer debentures. In these cases, the company does not maintain any records. The company pays the principal amount and the interest to the bearer of the instrument irrespective of whose name is written on it. Another significant feature of this type of debenture is that it is easily transferable in the market.

● Redeemable debenture
These are a type of debentures where the redemption date is explicitly mentioned on the company's debenture certificate. On the redemption date, the company is legally obliged to return the principal amount to the debenture holder.

● Irredeemable debenture

Unlike the redeemable debenture, which has a specific redemption date, these debentures continue for infinity, and there is no fixed date when the company needs to pay the debenture holder. It is redeemable only when the company goes into liquidation.

Now that you are aware of the different types of debentures; it would help to understand the uses of debentures.

The companies issue debentures with the aim to raise funds from the public. The companies use such funds for various purposes, including research and development and growth in the market. Companies prefer issuing debentures, which are essentially debt instruments over equity shares, for two reasons. One, issuing debentures does not lead to ownership dilution. Two, the cost of raising funds through debentures is much cheaper than the cost of raising funds through equity shares. In most cases, the companies issue registered secured NCDs as it protects the investors against their investment.

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