What are Debentures?
Debentures are a type of corporate bond that is created by companies. The money borrowed to create debentures is called the face value.
In exchange for the money, the company agrees to pay interest on debentures over a fixed period of time. Once the debenture matures, the company has to pay back the face value in exchange for the right to redeem it.
A debenture is a debt instrument not backed by collateral and is typically issued by a corporation. Debentures are often used to finance expansion or other major projects.
Interest on a debenture is usually paid at a fixed rate, although some debentures have variable rates of interest. The interest may be paid monthly, quarterly, or annually. The maturity date is the date on which the debenture expires and the principal amount must be repaid.
A debenture holder is a creditor of the issuing company and does not have voting rights. However, debenture holders may be able to convert their debentures into equity or voting shares at some point in the future.
Why Issue Debentures?
In addition to issuing shares to raise capital, a firm can supplement its capital using borrowings. Such borrowings may include both short-term and long-term loans.
A company needs short-term borrowings in the form of promissory notes, bills of exchange, bank overdrafts, cash credits, public deposits, etc. to finance its working capital, while long-term borrowings in the form of loans on a mortgage of property, term loans from financial institutions, public deposits for a long period, issue of debentures, etc. are required to finance capital expenditures.
The loan capital of a corporation refers to its long-term borrowings, the most important and prevalent means of which is the issuance of debentures.
Debentures are a form of borrowing capital, and the company is obligated to pay interest on them regardless of its profitability. A company’s approach to issuing debentures closely resembles its procedure for issuing stock.