Debenture Investing: The Ultimate Guide

A debenture is a long-term debt instrument issued by a corporation and governments to meet financial requirements. For instance; let's say you own a company and wish to expand the company by opening new branches but you are low on capital to achieve that, you can, in turn, seek financial loans from investors with an agreement to pay after some time.

Therefore, Debentures are long-term securities that pay a fixed rate of interest and are secured by assets. They provide a fantastic option for investors to earn income on their investments while avoiding the volatility of equities markets.

Debentures are sometimes known as "bonds with no coupons" since they do not pay interest until they mature. This implies that you will not receive regular revenue from your investment. Debentures are issued by firms when they need financing but aren't ready to go public. Other firms use them to raise capital without having to go through the process of issuing shares.

How Is Debenture Different From Bond?

Bonds and debentures share similarities as they are both financial instruments issued by either a company or a government to meet certain financial needs. However, there is one factor that distinguishes these two, and it is that bonds are backed by collateral, unlike debentures. In the case of liquidation, bondholders are paid before the debenture holders.

Feature Of Debenture

• It’s a long-term investment plan that may last up to 10 years and above.
• They have a fixed coupon rate but occasionally attract investors’ interest.
• Some companies that issue debentures can convert them into equalities (shares) after some time and this allows investors to get ownership in the business as well as the benefits of being a shareholder.
• Debentures are flexible debt instruments
• Repayments can be made by instalment or lump sum at the end of the agreement or maturity date.  

Types Of Debenture

Debentures are classified on four Major bases and they are;

• Security
• Tenure
• Convertibility
• Registration

Security Base Debenture

The security-based Debentures are classified into secured and unsecured debentures. A secured debenture is a financial instrument collected to buy assets. Nonetheless, secured debentures are backed by collateral, which is why in cases of bankruptcy, or on occasions where there is a default in repayment, the issuer may seize the company’s assets, and sell them, to recover their money back.

While the unsecure debenture is the typical opposite of the secure debenture. It is not backed by collateral, and it offers issuers higher interest rates.

Tenure Based Debenture

Tenure, which means a time frame, can be divided into two categories: redeemable debentures and irredeemable debentures. When it comes to redeemable debentures, the amount has to be repaid by the company within a specific time frame, or a redemption date. Unlike an “irredeemable debenture,” where a company has no fixed time to repay debt. Instead, the company can continue to issue the interest until it becomes bankrupt.

Convertibility Based Debenture  

This debenture factor is divided into two categories: convertible and non-convertible. As the name implies, convertible debentures are debentures that can be converted into equity shares after a particular time frame, while non-convertible debentures can not be converted into equity shares.

Registration Based Debenture

There are two types of debentures in this category. They are the registered debentures and the bearer debentures. Registered debentures are the type where debenture details are recorded under a specific name in the company. This type of debenture is difficult to transfer, and should an investor decide to transfer ownership of this debenture, they need to duly inform the organization. On the other hand, the bearer debenture is not registered under any specific name in the company, and because of that, this type of registration factored debenture is considered flexible and can easily be transferred.

Benefits Of Debenture

Many investors may ask why they should go for debentures rather than bank loans, One reason is because of the many restrictions imposed on companies by the bank. Some of these restrictions revolve around how the company should use the money borrowed, and on the grounds that the company has an outstanding loan, the bank may not issue another loan until the debt is paid.

This is why debenture have become a very convenient way for companies to raise extra funds. A debenture is not only beneficial to the issuer but also to the company. Therefore apart from this benefit, there are several other advantages of opting for debenture. And they are;

• Issuers of Debenture do not risk their asset
• The company’s ownership is not diluted unlike the case of shares.
• The interest payment is tasked deductively therefore it saves the overall tax amount for the issuing company.
• Debenture has Low risk and provides regular returns.
• Debenture holders are repaid before the shareholders in bankruptcy or corporate dissolution cases. This means that as a debenture issuer, you are at no risk of losing your money.  

Disadvantages Of Debentures

However, there is no such thing as perfection, which is why debentures have some drawbacks. So now that we have discussed the benefits/advantages above, we can now look at their limitations.

Drawbacks from the Issuer’s Point Of View

• Debenture issuers have zero control over the company’s decision as they are not shareholders.
• Issuers do not have any voting right in the company
• Investors cannot expect any shares in the company’s profit. Therefore the investors only invest their money and get the interest and the principal amount at the agreed time frame.

Drawback From The Company’s Point Of View

• The company is expected to repay the debenture’s interest and principal amount at the agreed time even if the company did not make a profit out of the financial instrument.
• Default in payment may affect the company’s creditworthiness.

Factors To Consider Before Investing In Debentures

• Creditworthiness which is; a company’s ability to pay interest and repay the loan in full at maturity is one factor to consider before investing in the debenture. Some credit rating agencies assess a company’s creditworthiness: Moody’s, Standard & Poor’s, and Fitch.
• you need to be fully aware of the charges and rates of interest issued by the company.
• Make your research on debenture investment properly before going into it and be well-equipped with information about the priority claim, interest rates, maturity dates, means of documentation, and the factors.

Finally! Although debentures may not be the best investment plan you may come across on the internet, but it is certainly one of many. Apart from the benefits, we have outlined above, debentures attract higher yields/ remuneration. The investment plan also allows investors to diversify.

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