Debenture: Meaning, Features, and Types.

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Every business needs funding to operate, as business operations are impossible without it. Businesses raise funds from various sources depending on their needs and eligibility, such as capital, loans, shares, bonds, debentures, etc. Among these different sources, a debenture is an option, and it possesses certain characteristics that set it apart from others.

Debentures are typically issued by companies (public and private) and governments, in compliance with the legal provisions of relevant laws, such as company law, etc. This method of raising funds is not available to other forms of business organizations, such as sole proprietorships, partnership firms, etc. Note: Private companies are not eligible to issue debentures directly to the public; they can only allot debentures privately.

What is a Debenture?

A debenture is a legal instrument used to raise funds from investors, and it represents a long-term debt for the business because the business is obligated to repay it according to the terms specified at the time of issuance. Since it is a debt for the business, it is recorded in the books of accounts and shown under the long-term liabilities head on the liabilities side of the balance sheet.

A person who holds a debenture is called a debenture holder and receives interest at a fixed rate according to the terms and conditions, and the principal amount at maturity. The maturity date and interest rate are specified in the debenture agreement at the time of issuance. Note: Debenture holders do not have voting rights in the business like shareholders, but the type of debenture can affect this.

This has advantages for both businesses and investors. For businesses, it’s a way to avoid share (ownership) dilution, and for investors, it’s safer than shares and provides them with a fixed interest income over time. Debenture holders have the right to transfer their debentures to anyone who wishes to buy them, but certain legal formalities must be completed.

Debenture is traded in a similar way to shares. If the company is listed, it is traded on the stock market, but if it is not listed, it is traded manually. Their trading is regulated under relevant laws and by governing bodies (such as the Stock Exchange Board, Memorandum of Association, Articles of Association, etc.). If the debenture falls under the category of convertible debentures, it can be converted into equity shares.

Features of a Debenture

Following are the features of a debenture:

1. Instrument:

A debenture is a financial instrument used by companies and government entities to raise funds from investors in the market, in exchange for a predetermined interest rate and repayment of the principal amount on a specified maturity date. Each debenture has a unique identification number, which distinguishes it from others and facilitates its management.

2. Governed:

A debenture is governed by relevant laws and regulatory bodies such as the stock exchange board, the company’s Memorandum of Association (MOA), and Articles of Association (AOA), etc. This regulation is in place because a debenture is a financial instrument used for raising funds, and its governance protects investors’ rights and ensures sustainable and controlled investment. This helps to build investor confidence in investing in debentures.

3. Secured:

A debenture is safer than shares because it provides debenture holders with a regular income, as it is issued at a fixed interest rate (except for floating-rate debentures), and the principal amount is also repaid to the holder upon maturity. Debenture holders also receive preferential treatment in the event of a company’s liquidation. For these reasons, it is a safer investment instrument compared to others.

4. Liability:

A debenture is a liability for a business, and it is a long-term liability because it represents a debt and is typically issued for a period of more than one year. It is recorded in the books of accounts and shown in the business’s final accounts, such as the balance sheet and other reports. In the balance sheet, it is shown on the liabilities side under the heading of long-term liabilities. Note: It remains a liability for the business until it is repaid.

5. Preference:

Debenture holders receive priority when a business is liquidated (wind up) because long-term liabilities are paid first, followed by other liabilities. Since debentures fall under the category of long-term liabilities, they are considered safer than other types of instruments, such as shares (equity and preference shares).

6. Classified:

Debentures are classified into different types, such as cumulative debenture, non-cumulative debenture, convertible debentures, partly convertible debentures, non-convertible debentures, redeemable debentures, irredeemable debentures, registered debentures, unregistered debentures, secured debentures, unsecured debentures, etc., and each type has its own characteristics that distinguish it from the others.

7. Transferable:

Debenture is transferable, meaning that debenture holders can transfer their debentures to another person, and this transfer does not affect the debenture’s existence. It continues to exist until its maturity date, but if it is a non-redeemable debenture, it remains in existence for the entire life of the business. Generally, debentures are issued for long periods, such as 5 years, 10 years, 20 years, etc., which is why they mature at a later date.

8. No Voting Rights:

Debenture holders do not receive any voting rights or ownership rights in the business, such as the right to vote at annual general meetings or participate in managerial decisions. This is because debentures represent a debt owed by the business, and issuing them does not require the business to give up any ownership stake, unlike shares. Debenture holders are simply entitled to receive interest and the principal amount at a specified time period.

Types of Debentures

Following are the types of debentures:

1. Cumulative Debentures:

Cumulative debentures are a type of debenture in which the interest is accumulated until their maturity or a specified date, and unlike other types of debentures, interest payments are not made periodically.

2. Non-cumulative Debentures:

Non-cumulative debentures are a type of debenture in which interest does not accumulate until maturity or a specified date, and the interest is paid periodically, such as quarterly, semi-annually, annually, or on a fixed date.

3. Redeemable Debentures:

Redeemable debentures are a type of debenture where the business redeems the debentures on the maturity date or repurchases them within a specified period. If an early redemption feature is available, the business can redeem them earlier if needed.

4. Non-redeemable Debentures:

Non-redeemable (Irredeemable) debentures are a type of debenture where the business does not redeem the debentures for the entire duration of its existence, or in simpler terms, they have no maturity date. They are only redeemed when the business ceases operations, and this is the exact opposite of redeemable debentures.

5. Convertible Debentures:

Convertible debentures are a type of debenture that can be converted into equity shares. This type of debenture is more attractive to investors who want to acquire the company’s equity shares in the future, and its convertibility makes it more flexible than other types of debentures.

6. Partly Convertible Debentures:

Partially convertible debentures are a type of debenture where a portion of the debenture can be converted into equity shares. These types of debentures are somewhat attractive to investors who wish to acquire the company’s equity shares in the future, and its partially convertible nature makes them slightly more flexible than non-convertible debentures.

7. Non-convertible Debentures:

Non-convertible debentures are a type of debenture that cannot be converted into equity shares. This type of debenture is less attractive to investors who wish to acquire the company’s equity shares in the future, and its non-convertibility makes it less flexible compared to convertible debentures.

8. Registered Debentures:

Registered debentures are a type of debenture where the debenture holder’s ownership is recorded in the company’s books, making them more secure than unregistered debentures. Their transfer requires the completion of legal documentation. The interest on the debenture is paid directly into the registered debenture holder’s account.

9. Unregistered Debentures:

Unregistered debentures are a type of debenture, also known as bearer debentures, where the ownership of the debenture holder is not recorded in the company’s books. This makes them less secure than registered debentures. No legal documentation is required for their transfer, as whoever possesses them is considered the owner. The interest on these debentures is paid directly into the debenture holder’s account.

Read Also:

• Share: Meaning, Features, and Types.
• Share Capital: Meaning, Features, and Types.
• Equity Share: Meaning, Features, and More.
• Preference Share: Meaning, Features, and Types.

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