What are Convertible Debentures?

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.

As with all investments, convertible debentures carry some risks, and these risks should be weighed before making a purchase. Financial advisors may have recommendations about specific companies and products which suit someone's investment needs, and it also pays to research independently. Many financial publications include reviews of various debt instruments and companies which can be used as guidelines when considering the purchase of convertible debentures and other types of investments.