What are debentures?

In corporate finance, a debenture is a medium used by large companies to borrow money for Long Term Period at a fixed rate of interest. The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in India and some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures and there are varying rates of risk and pay-off for these categories.

Debentures may be preferred over shares as they provide interest at fixed rate whereas there is no fixed income for shareholders. 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.

There are 2 types of debentures:

a. Convertible Debentures

Convertible debentures are those which can be converted into company shares at maturity at the option of debenture holder. Such debentures can be fully converted or partly converted. These types of debentures generally command a lower interest rate when compared with non convertible debentures.

b. Non Convertible Debentures

Non convertible debentures are those which cannot be converted into company shares. They are paid along with interest on maturity. These types of debentures generally command a higher interest rate when compared with convertible debentures.