What are Debentures and Their Types

The term "debenture" is derived from the Latin word 'debere' which means to owe a debt. A company may raise part of its capital by obtaining loans. The short term capital is mostly met by the company from the banks in the form of overdrafts and cash credits. The long-terms may be raised by issuing of debentures. Debenture thus is a long-term finance raised by a company through public borrowing.

Debenture is a security issued or allotted to the investors under the seal of the company who become creditors of the company. A debenture may, therefore, be defined as a document issued by the company as an evidence of its debt. It contains a contract for the repayment of the principal sum and the interest at a specified date to the debenture holder. The debenture holder has a preferential claim over the assets of a company over preference and ordinary share holders. The companies ordinance explains debentures in the following words “Debenture includes debenture stock, bonds, term finance certificate (TFC) and any other security other than the share of a company whether constituting a charge on the assets of the company or not”.

Under Islamic modes of financing, the debentures are replaced by the issuance of new corporate security known as term finance certificate (TFC), TFC entities its holders to share in the profits/loss of the company instead of receiving a fixed interest.

Features of Debentures

• It is an instrument indicating the indebtedness of the company.

• It has a nominal value like the share.

• It is a document issued under the seal of the company.

• The terms of issue, the repayment of the principal are specified on the back of the document.

• A fixed rate of interest is paid on debentures. The interest on debenture is a charge on the profit and loss account of the company.  

• Generally the debentures are covered by the security of the assets of the company.

Types of Debentures

The debentures are classified on the basis of the terms and conditions of their issue by the company. The main types of debentures are as under.

Bearer debentures

The bearer debentures do not show the name of owners on the bond. The holders of the bearer debenture are entitled to receive interest payment on the due dates.

Convertible debentures

In certain cases, the company allows the debenture holders to convert their debentures for the shares of the company, if the investor avails of this provision; he then becomes the shareholder of the company.

Equipment trust debentures

The debentures which are issued to raise funds for the purchase of new equipment of a business are called equipment trust debentures.

Irredeemable debentures

A debenture which his not payable during the life time of the issuing company is known as irredeemable debenture. These are payable either on the winding up of the company or at the time of any default on the part of the company.

Mortgage debenture

Mortgage debenture is one which is secured by a mortgage on the real property of the company. If the company fails to repay the borrowed amount at a specified period, the debenture holder has a legal right to sell the property and recover the loan.

Ordinary or naked debenture

Ordinary or naked debentures are those which do not carry any security in respect the repayment of interest or the principal. These have no priority and stand in the same position as any other unsecured creditors at the time of winding up the company.

Registered debentures

A registered debenture is issued in the name of the owner of the debentures. The name of the owner thus appears on the face of the bond as well as on the books of the company.  

Redeemable debentures

The debentures which are repaid after a certain period are known as redeemable debenture. The interest on the debentures is paid periodically but the principal amount is returned after a fixed period. Debentures are usually issued on redeemable basis. The company mostly borrows money on redeemable debenture.