A Business Encyclopedia

Convertible Debentures

Definition: The Convertible Debentures are a type of loan that can be converted into the stock of the company after a stipulated time period at the option of the holder or the issuer in special circumstances. These are issued with the intent to raise money to expand or maintain the business operations at a considerable low-interest rate.

The debentures are the long-term debt instruments on which the company is obliged to pay interest to its holders. Sometimes, the debentures are issued with an option of convertibility in which the debenture holder can get his debentures converted into the stock of the company, either fully or partly.

As per the SEBI, the following provisions apply in case the debentures are converted into the stock either fully or partly:

  1. The conversion time along with the conversion premium should be stated in the prospectus.
  2. The conversion, partial or full, must be at the disposal of the debenture holder, provided the conversion takes place at or after 18 months but before 36 months.
  3. The conversion is to be made optional with “put” or “call” option in case the debentures provide for conversion after 36 months.
  4. In case, the conversion period of fully convertible debentures exceeds 18 months; then a compulsory credit rating is required.

Through above provisions, it is clear that the convertible debentures could be of three types:

  1. Compulsory convertible debentures provide for the conversion within 18 months of the issue
  2. Optional convertible debentures provide for the conversion within 36 months of the issue.
  3. Debenture with “call “ or “put” option in case the conversion exceeds 36 months.

The convertible debentures are beneficial to the investor since they get an opportunity to become the owner of the company and might leave in case the company experiences the loss. But however, the convertible debentures are unsecured and in case the company goes bankrupt, the holder gets his money only after all the secured creditors are paid.

The major disadvantage to the issuer is that, if the company makes huge profits, then the investor would like to become the shareholder or the owner which results in the dilution of ownership in the company.

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