A corporate debenture is a type of unsecured investment that is issued by a corporation in order to raise money. Bonds are a common form of debentures and usually do not mature until the investor has held them for ten or more years. If the corporation declares bankruptcy, debenture holders are paid after common and preferred stockholders. The company has the option of issuing convertible debentures, which means that after a certain amount of time investors can convert bonds into equity shares.
When a firm issues a corporate debenture it is not secured by a piece of property or another form of collateral. Secured debt, such as a car loan, has property that can be liquidated if the debt cannot be paid. The amount of money obtained from the sale of the collateral substitutes as payment to the investor. Unsecured debt carries a greater risk and investors do not usually take out a debenture investment unless the corporation has a solid credit rating and payment history.
Bonds are the most common type of corporate debenture since they are openly traded in various international market exchanges. When an investor purchases a bond, he exchanges capital for a claim against the corporation's future earnings. A bond may sell at a price that is above, at, or below its maturity value. For example, a bond that is selling above par will cost more to purchase than the investor will be able to recoup at the end of its term.
A corporate debenture that sells above its face value usually carries a higher interest rate to make up for the difference in price. Since there is a higher long-term risk, the investor is compensated with a larger return rate. Bonds that sell below their face value or at a discount typically carry a lower rate of return since the long-term risk is very slight. An example of a low-risk bond is a 30 year treasury note issued by a national government.
From the firm's perspective, issuing a corporate debenture also carries greater long-term risk. While the corporation receives the short-term capital it needs to keep operations running, a high amount of issued bonds may lead to future financial problems. This problem usually arises when companies are unable to achieve long-term sales growth and profitability. Since debenture law deems that bonds are some of the last payment obligations to be met when bankruptcy occurs, a large amount of outstanding debt can lower a company's credit rating.
