A debenture bond is a type of debt instrument that is not secured by physical collateral, such as property or equipment. Instead, debenture bonds are backed only by the general creditworthiness and reputation of the issuer.
These bonds are issued by corporations and governments to raise funds for various purposes, such as financing ongoing operations or funding new projects. Debenture bonds carry a fixed interest rate and have a specific maturity date at which the principal amount is to be repaid to the bondholders.
Debenture bonds are essentially a promise by the issuer to pay the bondholders the principal and the agreed-upon interest. In the event of bankruptcy, holders of debenture bonds are considered unsecured creditors and are paid out after secured creditors.
There are two main types of debenture bonds:
- Convertible Debenture Bonds: These can be converted into equity shares of the issuing company after a specific period of time. This option is attractive to investors as it allows them to benefit from any appreciation in the company’s share price.
- Non-Convertible Debenture Bonds: These cannot be converted into equity shares and will repay the principal amount along with the interest at the time of maturity.
Debenture bonds are a common method of raising loan capital, and their holders are essentially creditors of the company.
Example of a Debenture Bond?
Let’s consider a hypothetical example:
A company named “GreenTech Innovations” wants to raise capital to fund its new research and development project. However, it doesn’t want to dilute its existing shareholders’ equity, so it decides to issue debenture bonds.
GreenTech Innovations decides to issue 5,000 debenture bonds, each with a face value of $1,000. These bonds carry an annual interest rate (coupon rate) of 6% and have a maturity of 15 years. This means GreenTech Innovations is looking to raise $5,000,000 ($1,000 x 5,000 bonds) from the market.
Investors who buy these debenture bonds become creditors of GreenTech Innovations. The company is obligated to pay these bondholders a 6% interest each year. So, if an investor purchases one bond for $1,000, they would receive $60 (6% of $1,000) per year as interest income.
At the end of 15 years, GreenTech Innovations would repay the principal amount of $1,000 to each bondholder, regardless of the company’s financial condition or market value.
If these were convertible debenture bonds, the bondholders would have the option (but not the obligation) to convert these bonds into equity shares of GreenTech Innovations at a predetermined rate at some point during the bond’s lifespan. This could be beneficial if the company’s share price appreciates significantly.
In the case of non-convertible debenture bonds, the bondholders would only receive the interest payments and the return of their principal at maturity, with no option to convert to equity.