Companies or Governments issue debentures to raise capital from the public as a loan. Also, there are different types of debentures that a company can issue based on its fund requirement. Thus, a convertible debentures is one among them, where the debenture holders can convert their debt holdings partially or fully into equity shares of the company. This article will discuss fully convertible debentures and their features, advantages, and disadvantages.
What is Fully Convertible Debentures?
The investors can fully convert these debentures into equity shares of the company on the expiry of the specified period. The company decides the conversion ratio at the time of issue. After converting these debentures, the debenture holders automatically enjoy the status of shareholders of the company. Also, the interest on these debentures will be paid only up to the date of conversion. Furthermore, the significant difference between a fully convertible debenture and other debentures is that the company can force the conversion into equity shares as per the notice.
A fully convertible debenture is suitable even for companies that do not have an established track record. Also, this conversion leads to an increase in equity capital.
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Features of Fully Convertible Debentures
The following are the key features.
The conversion price is the price at which the holders convert their debentures into shares. The conversion price is based on several factors, such as the current book value, market price, expected appreciation in the value of equity shares, etc.
The conversion ratio is the number of equity shares that the holder receives in exchange for a fully convertible debenture.
Quantum of Conversion
The number of debentures to convert is specified as a percentage of its face value. Further, the total amount to be converted is translated into the number of equity shares based on price.
The conversion value of an FCD depends on the investor’s right to receive equity shares. Thus, to arrive at the fully convertible value, they have to multiply the conversion ratio by the current market price per equity share.
Time of Conversion
It is the time period from the date of allotment of debentures. After the tenure ends, the issuer can also exercise the option to convert them into equity shares.
The coupon payments of a fully convertible debenture depend on the company’s credit quality and the current interest rate. As per the clause during the issue, the company pays the coupon payments half-yearly or annually.
The conversion value and investment value helps to determine the market price of the fully convertible debenture
check out our article on Difference Between Shares and Debentures
Advantages of Fully Convertible Debentures
The following are the advantages.
- Investors of FCD receive fixed interest payments called coupons.
- These debentures can help the firm survive difficult financial situations by enforcing the conversion and eliminating interest payments.
- Since the FCD holders become the shareholders of the company, they also ultimately gain when the company recovers.
- In the event of liquidation, the bondholders of fully convertible debentures are paid before the shareholders.
Disadvantages of Fully Convertible Debentures
The following are the disadvantages.
- The holders no longer receive interest payments after converting the debentures into equity.
- The issuing company can force conversion into equity shares that benefit existing shareholders more than FCD holders.
- Fully Convertible debentures receive lower interest payments compared to other traditional debt instruments.
- In case of bankruptcy, secured creditors are paid on priority. Thus, the fully convertible debenture holders will be paid only after secured debt holders are satisfied.