A debenture is a debt instrument issued by a company to raise funds from the public for medium- or long-term financial needs. Similar to a bank loan, it creates a debt obligation for the company and requires periodic interest payments to investors. However, instead of borrowing from a bank, the company raises funds through the capital market by issuing debentures that can be traded among investors. A debenture serves as a legal document specifying the amount borrowed, the rate of interest, and the repayment schedule. Upon maturity, the investor receives both the principal amount and the accrued interest. According to Section 2(12) of the Indian Companies Act, 1956, a debenture is “a document which either creates a debt or acknowledges it.” Generally, debentures carry a fixed rate of interest known as the coupon rate, and debenture holders receive interest payments based on the coupon rate mentioned in the debenture certificate
Types of Debentures
Debentures can be further classified on the following basis:
A. On the basis of Convertibility:
- Convertible Debentures: Those that can be converted into equity shares or other securities of the issuing company after a specified period. This conversion may be exercised according to the terms of issue and allows investors to benefit from the company's future growth. Initially, investors act as creditors, earning fixed interest, but upon conversion, they acquire the status of shareholders. Convertible debentures are further classified into:
- Fully Convertible Debentures: hese debentures are completely converted into equity shares after a predetermined period specified at the time of issue. Once converted, the investor ceases to be a debenture holder and becomes a shareholder of the company
- Partly Convertible Debentures: In this type, only a portion of the debenture is converted into equity shares, while the remaining non-convertible portion is redeemed after a specified period. Some companies may also provide a buy-back facility for the non-convertible part
- Non- Convertible Debentures: Do not carry any option for conversion into equity shares during their tenure. They remain purely debt instruments throughout their life and are redeemed in full upon maturity. Investors receive fixed interest payments and the principal amount at the end of the specified period.
B. On the basis of Registration:
- Bearer Debentures: Bearer debentures are freely transferable instruments, similar to negotiable instruments. Ownership of these debentures is determined by possession, and no record of the holder's name is maintained by the issuing company. They can be transferred from one person to another simply by delivery, without the need for any formal transfer procedure or registration. The person who purchases and possesses the debenture in good faith and for valuable consideration is regarded as its lawful owner.
- Registered Debentures: Registered debentures are those whose holders' names and details are recorded in the company's register of debenture holders. The transfer of such debentures requires a formal procedure. A transfer deed or transfer form must be duly signed by both the transferor and the transferee and submitted to the company along with the prescribed registration fee, if applicable. After verification, the company records the name of the new holder in its register, and only then does the transfer become effective. Registered debentures provide greater security as ownership can be easily established through the company's records
C. On the basis of Security:
- Secured or Mortgaged Debentures: The company's assets are pledged as security for issuing these debentures. Debenture holders have the right to sell the assets in order to satisfy their claims in the event of a default in the payment of interest or principal. A floating charge over all of the company's assets may be placed on the debentures. Asset sale revenues are first used to settle floating charge debentures.
- Simple, Naked or Unsecured Debentures: No security over the company's assets is provided for these debentures. Compared to other creditors, they are not given any preference. When the corporation is being wound up, they receive the same treatment as unsecured creditors. This makes them simple unsecured creditors.
D. On the basis of Coupon Rate:
- Specific Coupon Rate Debentures: As the name suggests, such debentures bear a specific rate of interest, which ought to be settled by the company irrespective of profits or losses.
- Zero-Coupon Rate Debentures: Such debentures do not carry any interest rate. It is sold by the issuing company to the buyers at a deep discount from its eventual maturity value. The difference between the issue price and the maturity value represents the gain or interest earned by the buyer.
E. On the Basis of Tenure:
- Redeemable Debentures: Redeemable debentures are those that must be repaid at the end of a specified period, either all at once or in instalments, either at a premium or at face value, during the lifetime of the entity.
- Irredeemable Debentures: Such debentures are not redeemed or paid back during the company's existence. Such redemption may be possible in the event that the company is wound up.