Corporate firms need to borrow funds to expand their business, day-to-day operations, merger or for any other reason. Debentures and bonds are two borrowing routes that can help corporations raise funds from the public. In this article, we will learn about one of these borrowing routes – debentures and their types.
What are debentures?
Any type of long-term debt instrument that isn’t backed by collateral is known as debentures. In simple words, debentures are unsecured debt instruments. However, you should know that debentures, along with bonds, are the most common types of debt instruments. When a company requires funds for either expansion or to run its day-to-day activities, it can do so by issuing debentures to the general public on interest. Click here to learn more about debentures.
These debentures are classified into types based on redeemability, convertibility, and transferability. Convertible, non-convertible, registered, unregistered, redeemable, and non-redeemable are a few debentures companies commonly use. This article will teach you more about types of debentures based on credibility, i.e., convertible and non-convertible debentures.
What are convertible debentures?
A long-term debenture issued by a company against interest that may be converted into stock after a set time is known as a convertible debenture. The distinguishing factor about these debentures is that they can be exchanged for sharing at pre-decided intervals. This helps debenture holders mitigate the risk associated with investing in unsecured debt.
What are non-convertible debentures?
Non-convertible debentures are fixed-income instruments that cannot be converted into shares, unlike convertible debentures. These have a predetermined maturity date, and the interest can be earned monthly, quarterly, or yearly, as you choose. They offer higher interest, minimal risk, liquidity, and tax advantage to investors compared to convertible debentures.
Convertible vs non-convertible debentures
Let us look at the points of differentiation between convertible and non-convertible debentures.
| Convertible Debentures | Non-convertible Debentures |
| Types of debentures that can convert into shares of the company are convertible debentures. | Those debentures that can convert into shares are called non-convertible debentures. |
| Types of convertible debentures: A. Partially Convertible Debentures – Those debentures whose some portion is convertible into shares. B. Fully Convertible Debentures – Those debentures which can be fully converted into shares at the time. | Types of non-convertible debentures (NCDs)
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| They have a lower interest rate as they can be converted into equity shares. | They have a higher interest rate in comparison to convertible debentures. |
| Their maturity value depends on the price of the company’s shares at that time. | The maturity value is predetermined for these debentures and remains unchanged at the time of maturity. |
| During bad market conditions, the debenture holder has an option to convert them into shares. | Even if the market conditions are not favourable, debenture holders do not have an option to convert and will have to hold them till maturity. |
| They hold dual status – creditor and shareholders. | They hold single status – creditor. |
| These are less risky since you can convert them into shares. | The risk associated is higher as compared to convertible debentures. |
Conclusion
To sum it up for you, debentures are unsecured debt instruments that are not backed by any instruments. You can further classify these debentures on the basis of convertibility, redeemability, and transferability. In this article, we discussed types of debentures based on convertibility – convertible and non-convertible debentures. Now that you are familiar with these types of debentures and the difference between them, it will help you decide how much to invest in debentures, bonds, and other investment options.
