Types of Debentures

What is Debenture?

A debenture can be described as a debt instrument issued by a company to the public in order to raise funds for medium or long-term usage. It is just like a bank loan, with debt obligation and liability for interest payment, but instead of borrowing from a bank, these are issued and traded in the capital market. A debenture is a legal document that states the amount invested or lent, interest due, and the repayment plan. At the conclusion of the term, the investor receives the principal and 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 are issued with a fixed rate of interest, which is called the Coupon Rate. A debenture holder receives interest according to the coupon rate specified in the debenture certificate.

Types of Debentures

Debentures can be further classified on the following basis:

A. On the basis of Convertibility:

• Convertible Debentures: Convertible debentures are debentures that have the ability to be changed into equity capital or any other security after the lapse of a certain period. The owners of the company may choose to do this at their discretion. Such shares give a creditor the privilege of being a secured investor of the company and changing his status to that of a shareholder if the returns are lucrative and the company has a good financial position. These are further classified as:

1. Fully Convertible Debentures: These are converted into equity shares after the lapse of a certain period specified at the time of issue of such debentures.
2. Partly Convertible Debentures: The type of convertible debentures, a part of which are partly converted into equity. The unconvertible part is redeemed after the lapse of a certain period or as specified. A company may offer partly convertible debentures with a buy-back facility as well.

• Non- Convertible Debentures: Such debentures do not bear any option to be converted into equity at any point of time in their lifetime and are redeemed fully at the end of a specified period, decided at the time of the issue of such debentures.

B. On the basis of Registration:

• Bearer Debentures: Similar to negotiable instruments, these debentures are easily transferrable. They are given to the buyer without any registration document. The debentures shall vest in and be owned by the person who, in good faith and for compensation, purchases them.
• Registered Debentures: To transfer these debentures, a specific process must be performed. A transfer voucher must be signed by the transferor and transferee i.e. both parties involved in the transfer. Along with registration costs, the form is delivered to the business. The purchaser’s name is then entered into the register.

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 installments, 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.