Debenture: Meaning, Types and Salient Features

A debenture is one of the capital market instruments which is used to raise medium or long term funds from public. A debenture is essentially a debt instrument that acknowledges a loan to the company and is executed under the common seal of the company. The debenture document, called Debenture deed contains provisions as to payment, of interest and the repayment of principal amount and giving a charge on the assets of a such a company, which may give security for the payment over the some or all the assets of the company. Issue of Debentures is one of the most common methods of raising the funds available to the company. It is an important source of finance.

Salient Features of Debentures

The most salient features of Debentures are as follows:

• A debenture acknowledges a debt
• It is in the form of certificate issued under the seal of the company (called Debenture Deed). It usually shows the amount & date of repayment of the loan.
• It has a rate of interest & date of interest payment.
• Debentures can be secured against the assets of the company or may be unsecured.
• Debentures are generally freely transferable by the debenture holder. Debenture holders have no 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 them is a charge against profit in the company’s financial statements.

Types of Debentures

The debentures can be divided into various types on the basis of security, performance, priority, convertibility and Records.  For more information on various types of debentures, please click here.

Issue of Debentures

Debentures can, be issued in three ways.

• At par: Debenture is said to have been issued at par when the amount collected for it is equal to the nominal value of debentures. e.g. the issue of debentures of Rs. 100/- for Rs. 100/-
• At Discount: Debenture is said to have been issued at discount when the amount collected is less than the nominal value, for e.g., issue of debentures of Rs. 100/- for Rs. 95/-. The difference of Rs. 5/- is the discount and is called discount on issue of Debentures. This discount on issue of debentures is a capital loss.
• At Premium: When the price charged is more than its nominal value, a debentures is said to be issued at a premium. e.g., issue of debentures of Rs. 100 each for Rs. 120, the excess amount over the nominal value i.e., Rs. 20 is the premium on issue of debentures. Premium received on issue of debentures is a capital gain. Please note that this Premium on issue of debentures cannot be utilised for distribution of dividend. Premium on debentures is shown under the head Reserves & Surplus on the liability side of the Balance Sheet.

Issue of Debentures for Cash

Debentures may be issue for cash at a par, at a discount or at a premium. When amount is payable in instalments entries will be similar to the issue of shares. Any premium or discount on issue of debentures is usually adjusted at the time of making allotment. Premium payable on redemption of debentures is also adjusted at the time of issue of debentures.

Issue of debentures for non-cash consideration

Debentures may be issued for consideration other than cash such as acquisition of business, or assets. It should be noted that ouch debentures may be issue at par or at a premium or at a discount.

Issue of debentures as a collateral security

Debentures can be issued as collateral security against a loan or overdraft from bank or other financial institution. Collateral Security means an additional or parallel security.

Redemption of Debentures

Debentures may be redeemed (repaid) a) at a par b) at a premium or c) at a discount.

• Redeemable at par: When debentures are to be redeemed at their face value they are said to be redeemable at par.
• Redeemable at a premium: When debentures are to be redeemed at an amount higher than their face value they said to be redeemable at a premium. Premium payable on redemption of debentures is a capital loss for the company. Such premium even though payable on redemption must be provided as a liability at a time of issue of debentures.
• Redeemable at a discount: When debentures are to be redeemed at an amount lower than their face value, they are said to be redeemable at a discount such discount is a capital profit for the company.

How debentures are different from bonds?

Bonds and Debentures, both are similar and holders of both of them are creditors to the company. Both bonds and debentures can be secured or unsecured. Generally, the bonds issued by the companies are secured by their assets. But there are unsecured bonds as well. The bonds issued by municipalities or government companies etc. are normally not secured by any assets.

Both bonds and debentures get priority over shares when company is liquidated. However, if the bonds are secured, they get priority over unsecured debentures.

What is Convertibility in Debentures?

Convertibility in debentures denotes conversion of a debenture to equity shares. On this basis they are of four types as follows:

• Partly Convertible Debentures (PCD):A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.
• Fully convertible Debentures (FCD):These are fully convertible into Equity shares at the issuer’s notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.
• Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.
• Non Convertible Debentures (NCD): Non-convertible debentures , which are simply regular debentures, cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts. Thus, these instruments retain the debt character and can not be converted in to equity shares

What is difference between Debentures and Shares

The key difference between a share and a debenture is that while share represents part of ownership of a company, debenture acknowledges loan or debt to the company. For more information, please click here.