What is a Debenture?

In business law, a debenture is a type of bond or similar debt instrument within the United States that is unsecured by collateral. Debentures are typically issued as a long-term funding tool to raise capital for larger projects or expansions. Due to their lack of collateral support, debentures generally count on the issuer’s credit worth and reputation. Both private corporations and government entities may issue debentures.

Key Takeaways 

• Debentures are bonds or other debt instruments that are unsecured by collateral.
• Both corporations and governments often issue debentures.
• Since debentures do not have collateral support, the repayment and terms of debentures are based on the general creditworthiness of the issuer.

How Debentures Work

When a particular business, corporation or government entity is looking for long-term funding to finance a project or raise capital, they may consider buying into a debenture. Debentures are an umbrella term that cover a variety of types of debt capital including stocks, bonds, and other similar debt securities.

Instead of relying on collateral, investors must count on the reputation of the issuing entity in order to ensure they will receive their return of investment plus interest income. As a result, debentures are typically only issued by extremely reliable debt issuers. For example, it is not uncommon for a government entity to issue a debenture, since they hold the ability to raise taxes in order to pay off their debts. Examples of debentures in the government include treasury bonds and treasury bills.

In most cases, an entity that issues debentures with lower creditworthiness will pay a high interest rate in order to compensate investors for increased risk.

Components of a Debenture Certificate

Valid debenture certificates must include a number of important details, including:

• The amount of the loan
• The repayment schedule
• The interest rate (also known as the coupon rate)
• Credit rating
• Convertibility rate
• Maturity date

Debentures in the United States vs Debentures in the United Kingdom

Debentures take on a different meaning in the United Kingdom.

In the US, debentures are considered medium to long-term loans that are issued to a business by an investor. Debentures are not backed up by collateral or any other physical assets. Simply put, debentures in the US are unsecured loans supplied in good faith. 

On the other hand, in the United Kingdom, debentures are instruments used by lenders that enable them to secure loan repayments against the debtor’s assets. Unlike in the US, charges from debentures can be taken out against a tangible asset such as property. These assets can be sold off in the event of a payment default.

Bottom Line

Dealing with debentures can be tricky, especially if you are new to the business world. If you need help with debentures, it is highly advised to contact a professional business or corporate law attorney.