What Is a Debenture Investment?

A debenture investment is essentially an unsecured loan to a business or organization, and companies sometimes offer debentures as a way to raise capital. Often, this type of investment is unsecured by assets and is backed only by the investor's estimation of the creditworthiness of the issuer. An indenture, or contact between the parties involved, stating terms and obligations is usually required. The precise implementation of this transaction varies by jurisdiction, however.

Risk associated with a debenture investment is generally greater than with traditional securities; consequently, it may offer a higher return. Intimate business knowledge of both the issuer and the limited market for such financial instruments is seen as a prerequisite for making a debenture investment. Such transactions are frequently gambles that the value of a company's unsecured note will rise along with the overall value of the company.

Typically, debentures are used by large organizations to raise working capital. The issuing company goes into debt to the investors until the base amount plus any interest is repaid or converted into an equivalent amount of company stock; if bankruptcy occurs, holders of a debenture investment are considered creditors and must receive consideration for payment from the company's remaining assets. Using this technique, a company can raise capital without using its assets as collateral or giving up an ownership interest in the company.

The return on a debenture investment is specified in the indenture, as is the term of the loan, and may be considerably higher than what could be expected from a similar investment in the company's stock. The higher return comes at the expense of an ownership interest in the company, however. In a debenture investment, the investor has no say in how the company uses the money.

Regulation of a debenture investment varies by jurisdiction. In the United States, this type of investment refers to an unsecured corporate bond, where there is no asset or income stream assigned to the repayment of the loan. The Trust Indenture Act of 1939, however, requires an indenture fully disclosing the terms of the transaction and the appointment of a debenture trustee when a debt offering is in excess of $5 million US Dollars (USD). If the issuer becomes unable to meet its financial obligations, the trustee may be empowered to seize company assets and repay the investors.

In the United Kingdom, a debenture is usually secured by a charge on assets or a mortgage secured on a particular property. Consequently, a debenture investment would not be given a more favorable rate of return than most traditional investments. In Canada, the loan is not secured by specific assets. In case of bankruptcy, the investors are given a higher repayment status than are other holders of unsecured debt. A debenture in many parts of the world implies an assignment of the issuer's assets to secure the terms of the loan.