Debenture is a long-term financing instrument used by companies for raising capital. It is a written document that acknowledges a debt. The holder of debenture gets fixed interest on the investment. They are considered the creditors of the company. In the case of bankruptcy of the company, the debentures holders have priority over shareholders for the redemption of payment. A debenture is unsecured as there is no pledge on specific properties rather it is secured by all properties of the company. Companies issue different types of debentures.
Based on Security
When security is concerned, debentures are of two types, naked and secured. Naked or unsecured debentures are not secured by any assets for repayment of interest and principal amount. Secured or mortgaged debentures are secured by particular assets of the company in respect of repayment of interest and principal amount. In case of bankruptcy, the mortgaged debentures have right to recover the payment of principle and unpaid interest from the realization of mortgaged assets.
Based on Tenure
Debentures are issued considering time. They are classified as redeemable and irredeemable debentures. Redeemable debentures are redeemed at the end of certain period specified on the debentures, at the option of the company or by installments under the issued terms. Irredeemable debentures (also called perpetual debentures) do not have any rights to claim redemption during the existence of the company. However, they can claim for redemption only when the company fails to pay interest or gets bankrupt.
Based on Convertibility
Convertible debentures can be converted into equity shares or some other security at the option of the company or the debenture holder. They are either fully or partly convertible. A nonconvertible debenture does not have any such flexibility. They cannot be converted to any other security. Companies mostly issue nonconvertible debentures in the market to retain their equity shareholdings.
Based on Registration
Registered debentures are those in respect of which all information of the debenture holders are registered with the company. They can only be transferred to others by signing a transfer deed. Bearer debentures can be transferred by the way of delivery and the interest is paid to those who present the interest coupon attached to the debenture.
Based on Coupon Rate
Specific coupon rate debentures provide the holders with specific rate of interest, also called coupon rates. The rate of interest can be fixed or floating. Zero coupon rate debentures do not carry any rate of interest and are issued at discount. The difference between the actual value and the issue value is the treatment as the benefit of carrying such debentures.