What Does Convertible Debenture Mean?

A type of loan issued by a company that can be converted into stock by the holder and,
under certain circumstances, the issuer of the bond. By adding the convertibility option
the issuer pays a lower interest rate on the loan compared to if there was no option to
convert. These instruments are used by companies to obtain the capital they need to grow
or maintain the business.

Convertible Debenture

Convertible debentures are different from convertible bonds because debentures are
unsecured; in the event of bankruptcy the debentures would be paid after other fixed
income holders. The convertible feature is factored into the calculation of the diluted per-
share metrics as if the debentures had been converted. Therefore, a higher share count
reduces metrics such as earnings per share, which is referred to as dilution.

Convertible Debenture:

There are different motives for issuing convertible debentures that are witnessed among the
issuers. From the issuer's point of view, the principal motive of financing with the help of convertible
debentures is diminished cash interest payment. Nonetheless, in substitution of the advantage of
decreased interest payments, the stockholder's equity value is diluted as a result of stock dilution.
This is anticipated when the convertible debenture holders substitute the debentures with fresh
stocks.

The popularity of convertible debentures among the issuers is increasing at a rapid pace and there
are various explanations for their growing applications. The explanation behind this can be broadly
categorized into the following types:

Conventional or Traditional Explanations

Reviews offered by finance professionals have opined about two common motives for issuance of
convertible debentures and they are the following:

• They enable the companies in issuing loans at a cheaper rate

• They offer the companies a chance for issuing equity shares at a premium on the present
value in the future

However, these explanations are debatable due to the following reasons

• Cheaper Debt: The coupon rate offered by debentures with warrants or convertible
debentures is usully less in comparison to the common debentures.
• Equity at a premium: The exchange price related to a convertible debenture or a
subscription value for practicing the warrant is usually more in comparison to the price
on which the stock or equity may be issued at the present time. Therefore, a number of
finance professionals assume that debentures with warrants or convertible debentures
allow a firm in issuing equity at a premium. This is also debatable because if the
conversion price of a stock is $25, and the share price falls below $25, then the
convertible debentureholders would not practice the conversion option. In such a
situation, the firm is not guaranteed about an issue price of $25 in the future. Thus it can
be concluded that convertible debentures are not dependable measures to issue stock or
equity at a premium.
Contemporary Financial Explanations
Contemporary financial theories explain better reasons behind the recognition of debentures with
warrants or convertible debentures. According to these theories, the motives for issuing
convertible debentures are the following:

• Financial Synergy: Debentures with warrants or convertible debentures are suitable

while it is quite expensive or not easy to analyze the risk features of the issuer.
Convertible debentures offer a security measure from erroneous risk analysis.
• Cash Flow Matching: The companies opt for financing tools that are easily maintained.
A nascent but risky company should look for convertible debentures due to the smaller
interest burden at the beginning stage.

• Agency Costs: Convertible debentures with warrants are able to extenuate difficulties
faced by agencies related to financing.

Convertible debentures are debt instruments which can be converted into another type of
security, classically stock in a company. Companies may use convertible debentures as a
financing tool which allows them to raise capital without having to sell stock. There are several
different types of convertible debenture available, and it can help to consult a financial advisor
when considering the purchase of these debentures. In a classic example of a convertible
debenture, a company might issue bonds, using the capital from the bond sales to fund a project.
The bondholders could opt to convert their bonds into stock at an agreed-upon price, or to accept
repayment of the bond funds. For the seller, this convertible debenture carries a lower interest
rate, and for buyers, it carries a potentially higher return, as the value of the stock may grow,
allowing the buyer to take advantage of the agreed-upon sale price to make a significant
profit.Debentures are unsecured. Buyers rely on the reputation of the issuer to ensure that they
will be paid back, rather than having the advantage of a secure backing. If a company fails and
the holders of debt instruments have not yet been repaid, they are considered creditors, and they
are entitled to some of the funds when a company is liquidated. People who purchase convertible
debentures run the risk of not recovering their funds, or of a radical decline in stock value which
makes conversion inadvisable. The issuer can also decide to convert a convertible debenture.
When this is an option, the debt instrument is known as a fully convertible debenture. Investors
can also opt to purchase partially convertible debentures, which can be converted partially into
shares, with the remainder of the value being repaid by the company. When purchasing
convertible debentures, people should take note of which kind of debenture is being purchased,
and any contingencies which may dictate how the debenture can be used and when it can be
converted, such as a maturation date or a minimum stock price for conversion.

Qualified institutional placement

Qualified institutional placement (QIP) is a capital raising tool, primarily used in India,
whereby a listed company can issue equity shares, fully and partly convertible
debentures, or any securities other than warrants which are convertible to equity shares to
a Qualified Institutional Buyer (QIB).
Apart from preferential allotment, this is the only other speedy method of private
placement whereby a listed company can issue shares or convertible securities to a select
group of persons. QIP scores over other methods because the issuing firm does not have
to undergo elaborate procedural requirements to raise this capital.

Why was it introduced?

The Securities and Exchange Board of India (SEBI) introduced the QIP process through a
circular issued on May 8, 2006[1], to prevent listed companies in India from developing an
excessive dependence on foreign capital. Prior to the innovation of the qualified
institutional placement, there was concern from Indian market regulators and authorities
that Indian companies were accessing international funding via issuing securities, such as
American depository receipts (ADRs), in outside markets. The complications associated
with raising capital in the domestic markets had led many companies to look at tapping
the overseas markets. This was seen as an undesirable export of the domestic equity
market, so the QIP guidelines were introduced to encourage Indian companies to raise
funds domestically instead of tapping overseas markets.

What are some of the regulations governing a QIP?

To be able to engage in a QIP, companies need to fulfil certain criteria such as being
listed on an exchange which has trading terminals across the country and having the
minimum public shareholding requirements which are specified in their listing
agreement.

During the process of engaging in a QIP, the company needs to issue a minimum of 10%
of the securities issued under the scheme to mutual funds. Moreover, it is mandatory for
the company to ensure that there are at least two allottees, if the size of the issue is up to
Rs 250 crore and at least five allottees if the company is issuing securities above Rs 250
crore.

No individual allottee is allowed to have more than 50% of the total amount issued. Also
no issue is allowed to a QIB who is related to the promoters of the company.

Who can participate in the issue?

The specified securities can be issued only to QIBs, who shall not be promoters or related
to promoters of the issuer. The issue is managed by a Sebi-registered merchant banker.
There is no pre-issue filing of the placement document with Sebi. The placement
document is placed on the websites of the stock exchanges and the issuer, with
appropriate disclaimer to the effect that the placement is meant only for QIBs on private
placement basis and is not an offer to the public.