A debenture is a type of bond secured against the reputation of the business and its general credit worthiness, rather than physical assets or collateral.
Government bonds are a debenture example where the risk to the lender is minimal.
As the most common type of long-term debt finance, debentures are a preferred type of loan for many companies. Compared to other alternatives, they offer the benefits of a lower interest rate and a later repayment date.
Similarly to equity, you can transfer debentures from one investor to another and are subordinate to other creditors (except for shareholders). As 'financial securities' they will need to comply with Financial Services and Marketing Act 2000 which can require costly legal advice.
Because they are treated similarly to equity but are not actual equity, they are of use to companies limited by guarantee that cannot have shareholder equity.
What are the types of debentures?
Debentures are classified based on their security, transferability and convertibility. They could also be redeemable or perpetual, depending on whether they have a specified repayment date. Based on interest rate, they can be split into fixed or floating rate debentures, zero coupon rate or secured premium debentures.
What are the risks of a debenture?
A potential risk of choosing a debenture as a source of long-term debt finance is the lack of interest payment flexibility. This could not only hold you back from growing your social business, but also be the potential cause for liquidation.
As a lender, you would also be relinquishing control over any assets involved in the debenture, as well as the vote and profits associated with your share in the business.