FinTech Glossary

What are Convertible Debentures

When a company issues a convertible debenture, the money it receives is initially recorded as a borrowing. The investor begins as a lender and receives the debenture under the conditions stated in the issue document. These conditions cover interest, any cash repayment, and the date or event that allows or requires conversion into equity shares.

The investor remains a creditor until the company allots those shares. Voting rights begin only after the conversion is completed. Security is handled separately. A secured debenture may carry a charge over company assets. An unsecured debenture has no asset cover, so repayment depends on the company’s financial capacity.

Indian company law sets two checks. Section 71 of the Companies Act, 2013 permits full or partial conversion at redemption and requires shareholder approval through a special resolution. Section 62(3) requires the conversion terms to receive that approval before the debentures are issued.

Much of the practical detail lies in the conversion clause. It should give the date or period, price or pricing formula, ratio, eligible amount, and required conditions. It should also explain who has the choice when conversion is optional. Any amount left as debt needs a separate redemption plan.

This route can suit a company that needs funds before it is ready to issue equity. Cash repayment falls if conversion later takes place. The trade-off appears at that point: new shares are issued, and the percentages held by existing shareholders can fall.

The regulatory path changes with the issue. Public issues, rights issues, preferential allotments, and private placements do not follow identical procedures. Securities and Exchange Board of India regulations may add pricing, rating, trustee, disclosure, or listing duties. The Companies Act, applicable rules, issue papers, and trust deed govern the rights attached to a particular issue.

Features of Convertible Debentures

The Issue Document Comes First

The issue document records what the company and investors have accepted. It covers interest, repayment, conversion, and the steps leading to allotment. A statement made in a meeting or email has no effect unless the papers support it.

How Conversion Takes Place

Conversion may be compulsory after a date or event. It may also depend on a choice given to the investor or company. In that case, the document must explain who can choose, how notice must be given, and what follows if the deadline or condition is missed.

A fully convertible debenture changes the entire eligible amount into shares. Under partial conversion, only the stated portion changes into equity. The unpaid balance continues as debt and follows its redemption schedule.

Working Out the Share Entitlement

The conversion price or ratio determines the number of shares. For instance, an eligible amount of ₹1,000 at ₹100 per share gives the holder ten shares, subject to the issue terms. Any pricing formula must use clear figures that both parties can check. The papers must also deal with fractional shares and any cash paid in their place.

Before Shares Are Allotted

A convertible debenture may be secured by company assets or issued without identified asset cover. Credit rating information indicates payment risk but cannot guarantee repayment.

Share allotment requires the company to have sufficient authorized share capital in place. It must review promoter holding, existing ownership, earnings per share, record dates, and settlement timelines.

Pros and Cons of Convertible Debentures for Business

Pros

• Funds arrive without an immediate issue of equity shares. Management therefore gets time to use the money before the ownership percentages change.
• Investors may accept a lower coupon in return for the conversion right. No saving is automatic; the issuer's credit, market demand, and conversion terms still influence the rate.
• Actual conversion reduces the cash due at redemption for the converted part. A company facing a large maturity payment may find that useful.
• Dilution is delayed until shares are allotted. Existing shareholders keep their percentage during the debt period, even though that percentage may fall later.
• The structure can interest investors who want creditor rights first and possible equity participation later. Their decision will still reflect the issuer's payment risk.

Cons

• Debt obligations continue before conversion. Interest, reporting duties, and covenants remain until conversion or redemption.
• An optional issue leaves the final cash requirement uncertain. If the holder chooses redemption under the terms, the company must have funds ready on the due date.
• New shares dilute existing holdings. Promoter percentage and earnings per share may fall, and the effect can be larger than management expected when the issue was approved.
• Poorly judged pricing creates trouble on either side. A generous ratio can hand over a large shareholding; a weak offer may give investors little reason to convert.
• The paperwork is heavier than a plain loan. Shareholder approval, valuation, disclosures, security creation, trustee work, and later allotment filings may all need attention.
• Several outcomes need funding plans before issue. Full conversion, partial conversion, and cash redemption place different demands on liquidity and leave different ownership results.

What is Difference Between Convertible and Non Convertible Debentures