What is Debenture? Definition of Debenture, Debenture Meaning

Therefore, these may carry relatively higher interest rates than otherwise similar bonds from the same issuer that are backed by collateral. Debentures are not generally issued with attractive terms, the services of debenture trustees are not available and the debentures cannot be converted into cash quickly. In contrast to our conditions, in the U.S.A., corporations are issuing bonds with highly attractive terms.

As with other bonds, most debentures pay regular interest rate returns (the coupon payment). This feature can be attractive on long-term debt instruments, since investors don’t have to wait until the maturity date or selling the asset to see a return. A bond is a debt instrument that governments and corporations use to raise money. A bond is similar to a loan in that the entity borrows money and pays periodic interest (coupon) payments. By the time the bond reaches maturity, investors are promised to get all their money back with interest. Examples of government-issued debentures are Treasury bonds and Treasury bills.

On the sample balance sheet below, the lines for long-term debt and the current portion of long-term debt are highlighted in yellow. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. We do not manage client funds or hold custody of assets, we help users connect with relevant financial advisors. Debentures are now becoming a more popular form of security due to the concrete measures taken by the Government.

The agreement gets registered at Companies House and it gets lodged against your business assets. Debentures may also be issued to banks and financial institutions as an additional or subsidiary security, in addition to certain principal security. The amount of the debentures is to be repaid within the period specified in the terms of their issue. A debenture is a loan certificate issued by the company to its holders. Instead of borrowing entire funds from an individual, a company can divide the funds into certain small denominations or parts (i.e., debentures).

The compensation we receive for such services enables this site to remain free for all to use and helps support the running costs. A debenture is a legal document and must be filed at Companies house as a matter of public record. It is therefore important that any debenture is reviewed and advice is taken from a solicitor prior to entering into a debenture. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.

Pros and Cons of Debentures

The funding can be in any form, and most commonly it relates to a long-term funding facility, such as a loan granted to a company that is repayable over a period of time. Bonds can be useful when it comes to an investment portfolio to help balance stock or high-risk securities. But, debentures are also a type of bond that can help your business raise capital. The business has options on the kind of  repayment they will take. This is where the issuer pays just a lump sum amount of money on maturity of the debt. Nonconvertible debentures are more traditional debentures that cannot be converted into equity of the issuing corporation.

• When the time comes to repay the principal, the issuer can choose either a lump-sum payment or to receive payment in instalments.
• This interest must be paid before dividends are paid to shareholders.
• Companies use debentures as fixed rate loans and pay fixed interest payments.

It is a legal agreement between the issuing company and the trustee who is usually a financial institution/ bank/insurance company/firm of attorneys. What is less known is that directors can also use the debenture to secure their own interests’ when lending to a company. As long as the debenture is registered at Companies House at the time the loan is made the debenture can secure the company assets for the director. Banks therefore issue debentures ultimately to protect themselves from losing money on loans they issue. The company may either repay the debt or even convert the debenture into shares or other debentures.

If a borrower has a good credit score, the company bets he or she will repay the debt. Similarly, investors lend money to companies and governments through debentures, trusting they’ll get the funds back. Imagine that the fictional Rivertown is preparing to build a new town hall. The local government decides to raise money for the project through bonds — specifically, debentures.

Let’s take a look at the various types of debentures companies can issue. Most of the time, a debenture gets issued if a company wants to raise capital for a specific reason or business purpose. Once a debenture gets issued, it can be either a floating or a fixed-interest coupon rate.

These debt instruments pay an interest rate and are redeemable or repayable on a fixed date. A company typically makes these scheduled debt interest payments before they pay stock dividends to shareholders. Debentures are advantageous for companies since they carry lower interest rates and longer repayment dates as compared to other types of loans and debt instruments. Debentures are the most common form of long-term debt instruments issued by corporations. The bond is the most common type of debt instrument used by private corporations and by governments. An investor loans a sum of money in return for the promise of repayment at the specified maturity date.

Debenture vs. Bond: What’s the Difference?

For this reason, investors must consider the creditworthiness of a corporation before investing in a debenture. You probably don’t have to worry about this with US Treasury bonds, since the federal government backs those. Debentures allow companies and governments to raise capital for the long term without offering assets as collateral. You may choose to invest in debentures as a means of increasing portfolio diversification. It’s important to compare debentures carefully, as some carry more risk than others. In addition, it’s important to compare and contrast debt instruments in general with equity alternatives.

Claim on Income and Assets

Debentures are unsecured bonds issued by corporations to raise debt capital. Because they are not backed by any form of collateral, they are inherently more risky than an otherwise identical note that is secured. Because of the increased risk, debentures will carry a comparatively higher interest rate in order to compensate bondholders. This also means that bond investors should pay careful attention to the creditworthiness of debenture issuers.

How Is a Debenture Different From a Bond?

Debenture consists of a fixed rate of interest payable to securities. Unsecured debentures are not given any security on the assets of the company. These types of debentures are treated as unsecured creditors at the time of winding up of the company. To ensure timely payment of interest and redemption of principal by a borrower, all debentures must be compulsorily rated by one or more of the credit rating agencies. Debentures are a mechanism through which specific liabilities are secured. Ultimately banks and lenders will only lend relatively limited sums without security.

Every additional issue of debentures becomes more risky and costly on account of the higher expectations of debenture holders. This enhanced financial risk increases the cost of equity capital and the cost of raising finance through debentures which is also high because of high stamp duty. A fixed rate of interest is payable to debenture holders, hence it is most suitable of the companies to earn higher profits. Generally, the rate of interest is lower than the other sources of long-term finance. Holding a debenture grants the lender powers and rights over the company’s assets, and commonly the company cannot sell or dispose of its fixed charge assets without the consent of the lender. A debenture is a form of security that a Company grants to a lender in exchange for funding.

As stated earlier, debentures are only as secure as the underlying issuer’s financial strength. If the company struggles financially due to internal or macroeconomic factors, investors are at risk of default on the debenture. As some consolation, a debenture holder would be repaid before common stock shareholders in the event of bankruptcy. Banks issue debentures as they provide the bank with powerful recovery tools in the event that a company defaults on its repayments to the bank.

Debenture Explained, With Types and Features

Further, the company has to pay interest regardless of whether it makes profits or not. The word ‘debenture’ itself is a derivation of the Latin word ‘debere’ which means to borrow or loan. what is equity method of accounting Debentures are written instruments of debt that companies issue under their common seal. These debentures are not mortgaged and they are issued without any charge on the company’s assets.

Main Sources of Working Capital

A fixed charge is normally taken out against a tangible asset such as property. It enables the lender to take ownership of the borrower’s assets and sell them off in the event of a payment default. With a fixed charge, the borrower would not be able to sell the asset without the lender’s consent.