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Meaning of Convertible Debentures
Convertible debentures can be term as debt security or loan that can be converted into equity shares after a stipulated period. The conversion of debentures into equity shares is at the option of the holder. However, in special circumstances, the issuer holds such conversion rights.
About Convertible Debentures
Business firms issue convertible debentures to avail tax benefit. The company can get the advantage of tax deduction on the interest paid to the investors. This reduces the cost of capital of the company. However, at the time of conversion when a company issues additional shares, the value of the equity shareholders decline due to stock dilution. There are many types of debentures which a company can issue. Two popular types of them are:
Debentures in which the company issues an interest-bearing loan that can be converted into equity shares after the stipulated time. The interest on these debentures is generally low. The debenture holders can opt for receiving the interest and principal amount at the time of maturity. However, if they are interested in becoming a part of the company, they can opt for converting the debentures into equity shares.
Unlike, these debentures, non-convertible debentures cannot be converted into equity shares. The interest rate on these debentures is usually high. The companies issuing non-convertible debentures have to make an arrangement with the bank by depositing a fixed amount and part of profits regularly.
The business organizations can issue debenture of any type depending on its suitability. When the firm issues convertible debentures, it has to select which type of convertible debenture it wants to issue. The following are the two types of convertible debentures:
Types of Convertible Debentures
Fully Convertible Debentures
Fully Convertible Debentures are those debentures in which the whole value of debentures is convertible into equity shares of the company. The holder of this debentures gets equity shares of the company in the ratio determined by the company at the time of issue.
Partly Convertible Debentures
Partly convertible debentures differ from fully convertible debentures. In partly convertible debentures, only some part of the debentures shall be eligible for conversion into equity shares. The ratio of conversion is determined at the time of issue of convertible debentures. The part of convertible debentures can be converted into equity shares only after the approval of debenture holders.
Convertible debentures are the quick and easy mode of finance for a business organization. The business can avail funds by issuing debentures and utilize it towards the growth of the business. These debentures give an opportunity to the investor to become a member of the company by converting them into equity shares at the time of maturity. The additional benefit of taxes on the convertible debentures also plays a significant role while selecting it as a source of finance for the business.1–4