What is Convertible Debentures?
What is Meant by Convertible Debentures?
A convertible debenture is a type of loan that a company can issue to raise money. The company promises to pay the investor a fixed interest rate on the loan, and the investor has the option to convert the loan into shares of the company’s stock at a later date.
So, if you buy a convertible debenture, you are basically lending money to the company, but you also have the option to become a shareholder in the company.
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What is the Role of a Convertible Debenture?
This is done to help the company raise extra money at lower cost of capital for various reasons like:
- To attract investors who are looking for growth opportunities.
- To avoid diluting existing shareholder ownership.
- To give investors a stake in the company’s success.
The most common reason is to raise capital at a lower cost than traditional bonds.
How does a convertible debenture works?
When a company issues convertible debentures, it works in the following steps:
- The investors receive a fixed interest payment on the debentures until they are converted into equity shares.
- The investors can convert the debentures into equity shares at a specified price, called the conversion price.
- If the company’s stock price is above the conversion price, the investors will typically convert their debentures into equity shares.
- If the company’s stock price is below the conversion price, the investors may choose to hold onto the debentures and continue to receive the fixed interest payments.
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What Impact Does a Convertible Debentures Have?
An issue of convertible debentures affects the issuing company and investors in various ways.
| Particulars | Issuing Company | Investors |
| Lower Interest rates | Save on borrowing costs | Fixed income with potential for equity upside |
| Deferred stock dilution | Does not have to issue new shares of stock until the bonds are converted | Lower risk than equity |
| Potential for equity financing | Additional equity financing without having to go through a traditional equity offering | Potential for capital gains by being a shareholder at a later date. |
| Tax advantages | Tax-deductible for the issuing company | Tax advantages in some cases |
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