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:

  1. The investors receive a fixed interest payment on the debentures until they are converted into equity shares.
  2. The investors can convert the debentures into equity shares at a specified price, called the conversion price.
  3. If the company’s stock price is above the conversion price, the investors will typically convert their debentures into equity shares.
  4. 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.

ParticularsIssuing CompanyInvestors
Lower Interest ratesSave on borrowing costsFixed income with potential for equity upside
Deferred stock dilutionDoes not have to issue new shares of stock until the bonds are convertedLower risk than equity
Potential for equity financingAdditional equity financing without having to go through a traditional equity offeringPotential for capital gains by being a shareholder at a later date.
Tax advantagesTax-deductible for the issuing companyTax advantages in some cases

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