Debenture capital refers to the funds that a company raises through the issuance of debentures, which are a type of long-term debt instrument. Debentures are an agreement or a contract between the company (debtor) and the debenture holders (creditors) where the company promises to pay a specified amount of interest during the life of the debenture and repay the principal amount on a specific date in the future.
Debenture capital is essentially borrowed capital that the company is obligated to repay at a later date. It is considered a liability on the company’s balance sheet. The interest that the company pays to its debenture holders is a fixed charge and must be paid regardless of whether the company makes a profit or loss.
There are two main types of debentures:
- Convertible Debentures: These debentures can be converted into equity shares of the company after a specified period. This provides an attractive option for investors as they have the opportunity to become shareholders and participate in the company’s profit.
- Non-Convertible Debentures: These debentures cannot be converted into equity shares. They offer a fixed rate of interest and are more like traditional loans.
Debenture capital can be a good way for companies to raise funds without diluting equity, but it also increases the company’s indebtedness, which can carry risks if the company’s income isn’t sufficient to cover the interest payments.
Example of Debenture Capital
Let’s consider a hypothetical example:
A company named “BioHealth Corp.” is planning to invest in new research facilities. The estimated cost for the facilities is $10 million. Instead of diluting the company’s equity by issuing more shares, BioHealth Corp. decides to raise the money by issuing debentures.
BioHealth Corp. issues 10,000 debentures, each with a face value of $1,000. These debentures carry an annual interest rate of 7% and have a maturity of 20 years. Therefore, BioHealth Corp. raises $10 million ($1,000 x 10,000 debentures) in debenture capital.
Investors who buy these debentures become creditors of BioHealth Corp. The company promises to pay these debenture holders a 7% interest each year. If an investor purchases one debenture for $1,000, they would receive $70 (7% of $1,000) per year as interest income.
At the end of 20 years, BioHealth Corp. would repay the principal amount of $1,000 to the debenture holder, regardless of the company’s financial condition or market value.
In this scenario, the $10 million raised through the issuance of debentures is referred to as debenture capital. It’s important to note that this capital is a liability for BioHealth Corp., as it’s an amount that the company has borrowed and has to repay in the future.