Debenture

Similar to bonds, debenture is a type of debt instrument is issued by governments and corporations for the purpose of obtaining capital. It’s backed by the reputation and known creditworthiness of the issuer rather than by assets or collateral.

Bond buyers purchase debentures because they see the bond issuer as “good for it”, meaning they are unlikely to stop making payments. There’s definitely a level of trust involved and a solid financial history is obviously required.

Debentures are actually the most common form of long-term loans that companies use. They are simple because they have a fixed date that the loan has to be paid off and they have a fixed interest rate. Debentures are paid out even before shareholders are paid. Compared to other kinds of loans, people seem to like debentures because of the low interest rate that you know won’t go up as well as a date far off in the future to pay off the loan, giving you plenty of time to get your act together.

There are two types of debentures: convertible and non-convertible.

Convertible debentures can convert into equity shares in the company after a certain amount of time. These types of bonds are the ones investors want because of the ability to convert to something potentially far more valuable than the investment.

And quite obviously, non-convertible debentures can’t be converted into shares. This means a higher interest rate for investors since they know they won’t be getting any of your shares in return.

All debentures have their own special little quirks. A trust indenture is how they start, which is basically just an agreement between the company and investors. The interest rate is then determined. The rate is usually fixed as this is one of the things that makes debentures attractive in the first place, but they can also be floating if your credit rating is poor.

Of course, the payback date of the debenture, or date of maturity, is also pretty important, especially for non-convertible debentures. There are a few different options for how to repay. One is to make one big payment on the date the loan matures, which is called a redemption out of capital. Another option is paying a certain amount each year until the loan is paid off, similar to a person making credit card payments. This is called a debenture redemption reserve.

 

EXAMPLE:

The date of maturity for our debenture is coming up but the date of maturity for our actual founders is still well in the future [ insert fart joke here].