Debentures: Overview, definition, and example
What are debentures?
Debentures are a type of debt instrument or bond issued by companies or governments to raise capital. Unlike secured bonds, which are backed by specific assets, debentures are typically unsecured, meaning they are not backed by collateral. Instead, they rely on the creditworthiness and reputation of the issuer to attract investors. Debentures typically pay interest to the holder over a fixed period, and the principal amount is repaid at the maturity date.
Debentures can be issued by both private and public companies and are often used for long-term funding. Investors who purchase debentures are essentially lending money to the issuer, with the promise of receiving periodic interest payments and the return of the principal amount when the debenture matures.
Why are debentures important?
Debentures are important because they provide a way for companies and governments to secure financing without needing to offer physical assets as collateral. This makes them attractive to both issuers and investors. For companies, debentures provide a relatively low-cost method of raising capital, especially for expansion or large projects. For investors, debentures offer a predictable income stream in the form of interest payments and may provide higher returns compared to other investment options like savings accounts or government bonds.
For businesses, issuing debentures allows them to secure long-term financing without diluting equity or ownership. For investors, debentures can be a secure investment option, though they come with the risk associated with the issuer's ability to repay.
Understanding debentures through an example
Imagine a company, XYZ Corp, that wants to raise $10 million to finance an expansion. Instead of issuing stock, XYZ Corp issues debentures with a 5-year term and an annual interest rate of 6%. Investors purchase these debentures, lending money to XYZ Corp in exchange for annual interest payments. At the end of the 5 years, XYZ Corp will repay the principal amount of $10 million to the debenture holders.
In another example, a government may issue debentures to fund infrastructure projects, such as building highways. Investors purchase these government-issued debentures, which offer a guaranteed return through interest payments, and the government repays the principal once the debentures reach maturity.
An example of a debenture clause
Here’s how a clause like this might appear in a debenture agreement:
“The Issuer hereby issues [X] number of Debentures with a nominal value of $[Amount] each, bearing an interest rate of [X]% per annum, payable annually. The Debentures will mature on [Date], and the principal amount will be repaid to the Debenture holders in full at that time, subject to the terms and conditions outlined herein.”
Conclusion
Debentures are a key financial instrument used by companies and governments to raise capital by borrowing from investors. They are unsecured, meaning they are not backed by collateral, but rely on the creditworthiness of the issuer. For investors, debentures provide a steady income stream through interest payments and are typically considered a safer investment than equity shares. For issuers, debentures offer a way to finance large projects or expansions without giving up ownership or offering assets as security.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.