Types of Debentures

Debentures are financial instruments through which companies can raise debt. They are basically documents that evidence the existence of a debt in a company’s name. Companies issue debentures extensively because debt capital is cheaper to raise. Let’s take a look at the various types of debentures companies can issue.

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Types of Debentures

The definition of debentures under Companies Act, 2013 says companies cannot issue debentures carrying voting rights. Apart from this, there are no other specific restrictions. Hence, companies are free to issue many other types of debentures.

We can classify types of debentures in the following five categories: security, convertibility, permeance, negotiability, and priority.

Based on Security

• Secured Debentures
• Unsecured Debentures

Based on Convertibility

• Convertible Debentures
• Non-convertible Debentures

Based on Permeance

• Redeemable Debentures
• Irredeemable Debentures

Based on Negotiability

• Registered Debentures
• Bearer Debentures

Based on Priority

• First Mortgage Debentures
• Second Mortgage Debentures

Let us discuss all types of debentures in detail.

1. Types of Debentures on the basis of Security

In terms of security, a debenture may basically either carry some security or it might not. Thus, debentures can be of two types here:

a) Secured Debentures: These debentures carry a charge on some assets of the issuing company. In case the company fails to repay the debt, its assets will be sold off to pay creditors.

This security on debentures may be of two types: Fixed-charge or Floating charge. In the case of a fixed charge, the security relates to a specific asset of the company. On the contrary, a floating charge covers all assets of the company in general.

b) Unsecured Debentures: These debentures are very risky for investors. This is because they do not carry any security or charge on the company’s assets. The company only promises to pay the debt amount and interest. Its assets are not liable for attachment in case of its failure to repay.

Read the Advantages and Disadvantages of Debentures here in detail.

2. Types of Debentures on the basis of Convertibility

In order to make their debentures attractive to investors, companies can make them convertible. On grounds on convertibility, debentures may be of the following two types:

a) Convertible Debentures: These debentures convert into equity or preference shares after a specific period of time. This conversion may be either compulsory or optional at the debenture holder’s discretion. Further, it may be either fully convertible or partly convertible. In terms of the value of the shares that debentures convert into, they may be at par or even at premium or discount.

b) Non-convertible Debentures: On the contrary to convertible debentures, non-convertible ones remain debentures. They are not convertible into shares.

3. Types of Debentures on the basis of Permanence

In terms of permanence and duration, debentures are of the following types:

a) Redeemable Debentures: These debentures are redeemable on a specified date. For example, if a debenture’s maturity period is 5 years, it becomes redeemable on the expiry of 5 years. These 5 years will start from the date of issue of the debenture.

b) Irredeemable Debentures: Irredeemable debentures do not have a specific maturity date. They last throughout a company’s lifetime. Thus, the company redeems them only when it faces liquidation.

4. Types of Debentures on the basis of Negotiability

The aspect of negotiability basically relates to transferability. This ground differentiates debentures on the basis of whether they are freely transferable. It divides debentures on the following two grounds:

a) Registered Debentures: As the name suggests, the details of these debenture holders are registered in the company’s records. Only the debenture holders can redeem these debentures. Hence, they are not freely transferable. They can be transferred only if relevant provisions of the Companies Act, 2013 are fulfilled.

b) Bearer Debentures: Companies do not register details of debenture holders in this case. They can be redeemed by the person owning them, without their identity being checked. This happens because these debentures are freely transferable. Thus, anybody can sell and buy them from their holders.

5. Types of Debentures on the basis of their Priority

Just like shares, companies rank debentures also in terms of priority. Investors prefer buying instruments having priority because it helps them reduce their risks. Debentures can be of the following two types in this case:

a) First Mortgage Debentures: As the name suggests, companies repay these debentures first. Debenture-holders get their money before all others in their category.

b) Second Mortgage Debentures: These debentures are repaid only after the first mortgage debentures are satisfied.

Solved Examples for You

Question: Match the following characteristics with the relevant debentures they apply to.

(a) No fixed date of maturity                                                                                (1) Convertible debentures

(b) Freely transferable                                                                                           (2) Second mortgage debentures

(c) Convertible into shares                                                                                    (3) Irredeemable debentures

(d) No first preference                                                                                           (4) Bearer debentures

(e) Backed by assets                                                                                               (5) Secured debentures

 

Answers:     (a) ↔ (3)          (b) ↔ (4)          (c) ↔ (1)          (d) ↔ (2)          (e) ↔ (5)