Types of Debentures

Debentures are classified on several independent bases at once, and any single debenture issue is usually described by combining one term from each basis — for example, a company may issue "secured, redeemable, non-convertible debentures" as a single class.

On the basis of security, debentures are secured (also called mortgage debentures) or unsecured (also called naked or simple debentures). A secured debenture carries a charge over the company's assets, created in favour of the debenture-holders through a Debenture Trust Deed, giving the holder the right to recover the amount due from those specific assets — either a fixed charge, tied to one identified asset such as land or a building, or a floating charge, hovering generally over the company's changing assets (such as stock-in-trade) until it 'crystallises' on a default. Where two or more secured-debenture issues carry a charge on the same asset, the one created earlier in time is called a first mortgage debenture, entitled to be repaid ahead of a later charge on the same asset, called a second mortgage debenture. An unsecured debenture carries no charge at all; the holder ranks merely as an ordinary, unsecured creditor if the company defaults, so unsecured debentures are naturally regarded as riskier and less attractive to a cautious investor.

On the basis of convertibility, debentures are convertible or non-convertible. A convertible debenture gives the holder a contractual right to convert the debenture, in whole or in part, into equity shares of the company, at a stated ratio, after a fixed period stated in the terms of issue — such a debenture is naturally attractive to an investor who wants the security of fixed interest for now, with the option of later sharing in the company's growth as a shareholder. Convertible debentures may be Fully Convertible Debentures (FCDs), converted entirely into equity, or Partly Convertible Debentures (PCDs), where only part of the face value converts and the remainder is redeemed in cash. A non-convertible debenture (NCD) carries no such right at all and remains pure debt throughout its life, redeemed only in cash on maturity; because there is no prospect of sharing in the company's future share-price growth, non-convertible debentures are the more common choice for a company that simply wants straightforward borrowed capital, without diluting its equity base even in the future.

On the basis of redemption, debentures are redeemable or irredeemable. A redeemable debenture is repayable — either in a lump sum at the end of a fixed period, or in instalments over a period — according to the terms stated at the time of issue; the great majority of debentures issued in practice are redeemable. An irredeemable debenture (also called a perpetual debenture) carries no fixed date of repayment at all, and becomes repayable only on the happening of a specified contingency, such as the company's winding up, or on a default in payment of interest. …