Debenture - What is a debenture?

Defintion: A debenture is a medium to long-term debt format that is used by large companies to borrow money.

Debentures are the most common form of long-term loans that can be taken by a company.

Debentures are usually loans that are repayable on a fixed date, but some debentures are irredeemable securities (these are sometimes called perpetual debentures).

Most debentures pay a fixed rate of interest. It is required that this interest is paid prior to dividends being paid to shareholders. Furthermore, most debentures are secured on the borrower’s assets, although some are not (these can be known as naked or unsecured debentures – most debentures in the USA are unsecured).

Debenture holders

Debenture holders (investors) do not have any rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures.

The interest paid to debenture holders is calculated as a charge against profit in the company's financial statements.

Advantages

The main advantage of debentures to companies is the fact that they have a lower interest rate than e.g. overdrafts. Also, they are usually repayable at a date far off in the future.

For an investor, their main advantages are that they are often easy to sell in stock exchanges and they contain less risk than e.g. equities.

Convertible vs. non-convertible

There are two types of debentures:

Convertible debentures: Convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time. Convertible bonds are more attractive to investors since the bonds have the ability to convert and also attractive to companies since they typically have lower interest rates than non-convertible corporate bonds.

Non-convertible debentures: regular debentures which cannot be converted into equity shares of the liable company. Since they are not able to convert, they usually carry higher interest rates than convertible debentures.