Debentures are a key financial instrument for corporate financing, representing a debt obligation without ownership rights. They can be secured or unsecured, with fixed or variable interest rates, and may be convertible into equity. The text explores their characteristics, risks, issuance process, and strategic importance in balancing a company's capital structure for optimal cost of capital.
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Debentures are a type of long-term borrowing used by corporations to raise funds
Unsecured and not backed by specific assets
Debentures are often unsecured and do not have specific assets backing them, but they still represent a debt obligation with a predetermined repayment date and interest payments
Fixed or variable interest rate
Debentures may have either a fixed or variable interest rate
In the event of a company's liquidation, debenture holders have a claim on the company's assets, ranking above shareholders but potentially below other secured creditors
Unlike equity shares, debentures do not confer ownership or voting rights to holders
Debenture holders are entitled to fixed interest payments, while shareholders receive profit-dependent dividends
Collateral vs. no collateral
Bonds are typically secured by collateral, while debentures may or may not be
Specific assets pledged vs. no specific assets pledged
Secured debentures have specific company assets pledged against them, while unsecured debentures do not
Debentures can be classified as convertible, which can be converted into equity shares, or non-convertible, which are purely debt instruments
Non-convertible debentures offer a fixed income, while convertible debentures have the potential for capital gains if the company's stock price appreciates
Debentures are redeemed at the end of their term, regardless of whether they are convertible or non-convertible
Debentures offer a fixed interest rate and have a set maturity date, making them advantageous for financial planning
The obligation to make regular interest payments can strain a company's finances, and debenture holders may still face losses in a liquidation scenario
Secured debentures can limit a company's flexibility, and the long-term nature of debentures requires careful financial planning
The cost of debt (Kd) is calculated by considering the interest rate, net proceeds, and applicable tax rate, assisting companies in comparing debenture financing with other options and helping investors assess the risk and return
The process of issuing debentures involves board approval, drafting a trust deed, and disseminating a prospectus to potential investors, with strategic considerations such as interest rate, creditworthiness, maturity period, and asset availability
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Debenture repayment terms
Debentures are repaid at a predetermined date, including principal and periodic interest.
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Security status of debentures
Debentures are often unsecured, not backed by specific assets, may have fixed or variable interest.
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Debenture holder's claim in liquidation
In liquidation, debenture holders rank above shareholders but may rank below secured creditors.
