Definition: Debentures are the debt instruments used to raise additional capital from the general public, usually backed by the integrity and the creditworthiness of the issuer.
Debentures usually offer more flexibility than a term loan as there is more variety with respect to the maturity, security, interest rate, repayment and special features. Debentures are the promissory notes issued to the debenture holders, often called as creditors of the firm, for a fixed period of time and at a fixed rate of interest.
The company is legally obliged to pay interest and principal at specified times, the failure of which could even lead to bankruptcy. When the debentures are issued to the investing public, a trustee is appointed, which is generally the bank or a financial institution or the insurance company. These are appointed to safeguard the interest of the debenture holders and ensure that issuer firm fulfills its contractual obligations.
The debenture may carry a “call” feature that offers the issuing company an option to redeem the debenture before its maturity date. Also, there is a “put” option that gives the debenture holder an option to seek redemption at a predetermined price and in a specified time period.
The debenture is either convertible or non-convertible. The convertible debenture is the one that can be converted into the equity shares at the option of the debenture holders whereas, the non-convertible debenture is not convertible into equity shares.
The debentures enjoy all the benefits of the term loan, but however, the major difference between these two is: before the issue, the firm has greater flexibility in designing the debenture issue. But once the debentures are issued the firm can hardly make any changes in the terms of the issue.