Debentures for Raising Capital
When a company or an organization needs to raise capital, it can issue loans. Usually, these loans are in the form of investment bonds, which accrue a set rate of interest over a fixed maturity period. Sometimes, a company issues debentures instead of bonds. Debentures are debt instruments. A Debenture, unlike a bond, is not backed by any financial security or asset like gold or property. The only backing force behind a debenture is the reputation and good will of the company.
Convertible and Non-convertible Debenture
Debentures can be converted into company stocks at the whim of the holder. But this is the case only with Convertible Debentures. As the name suggests, a Non Convertible Debenture is a debenture which cannot be converted into company stocks and shares, even in cases of market volatility. In this case, an NCD (Non Convertible Debenture) works much like an IOU card. Why take the risk of investing in NCDs if they cannot be liquidated into equity? The answer is interest.
NCD vs FD
Most low risk investment opportunities, be it fixed deposits or income bonds, do not usually have returns greater than 8 to 9 %. But Non Convertible Debentures can provide an interest rate up to 11 to 12%. This being said, Non Convertible Debentures do come with some risk. There is of course no investment with zero risk. Being aware of this risk is important. A company trying to raise capital through debentures has to be accredited by an appropriate agency like CRISIL or the Fitch ratings. A higher rating implies more stability and a lesser chance that the company will default on its payment. For instance, a -AAA CRISIL rating means a company is less likely to default on its returns as compared to a -AA rating. Companies with lower ratings and lesser stability might push their interest rate of return higher to make the debenture more lucrative. As a buyer, you have to be wary of such companies to ensure that you minimize your risk of investment.
When can I get the Interest?
Another decision you should make while looking to invest in Non Convertible Debentures is the schedule of interest payout. Usually, companies pay out interests annually. But there are also debentures that have a quarterly or half yearly payout option. Another smart option is opting for cumulative returns, especially if the debenture is a long term one. In this case, the interest accrued is invested back into the principal of the debenture, thus compounding your investment every year.
Check the Company’s reputation
Before investing in a Non Convertible Debenture, make sure you make a check list of certain factors. Keep in mind the credibility of the company, its overall financial health and its use of funds. If you notice diversion of funds for non-core related business purposes, you should be wary. What makes Non Convertible debentures tricky is that once the investment is made, it is not possible to prematurely exit without losing money since the debentures cannot be converted into company stocks. Avoid going for companies with lesser credibility and higher rate of returns. After all, it is better to be safe than sorry!