What Is a Fully Convertible Debenture?
A fully convertible debenture (FCD) is a type of debt security in which the whole value of the debenture is convertible into equity shares at the issuer's notice. The ratio of conversion is decided by the issuer when the debenture is issued. Upon conversion, the investors enjoy the same status as ordinary shareholders of the company.
Understanding Fully Convertible Debenture (FCD)
A debenture is a medium to long-term debt instrument used by large companies to borrow money at a fixed rate of interest. This fixed income security is unsecured, meaning there is no collateral pledged to guarantee the interest payments and principal repayments. Thus, a debenture is backed by the full faith and credit of the issuer. In the event that the company defaults or goes bankrupt, the debenture holder will get his invested funds only after all secured creditors have been paid.
A debenture can be non-convertible or convertible. A non-convertible debenture is simply a standard debenture that cannot be converted into equity at the issuing company and, thus, commands a higher interest rate than convertible debentures. A convertible debenture, as the name implies, can be converted into common shares of the issuing company after a predetermined period of time as stipulated in the trust indenture. Since the debt holder has the advantage of enjoying any share price appreciation of the company after conversion, convertible debentures are issued with lower interest rates than non-convertible debentures.
A convertible debenture can be partially or fully converted into equity. Partially convertible debentures (PCDs) involve redeeming a fraction of the value of the security for cash and converting the other part of the debenture’s value into equity. A fully convertible debenture (FCD) involves a full conversion of the debt security into equity at the issuer’s notice. The full conversion of debentures to equity is, in fact, a method used by a company to pay off its debt by paying its debenture holders in kind, that is, equity. The payment in kind consists of repayment of principal and payment of interest.
At the time of issuance, the trust indenture highlights the conversion time, conversion ratio, and the conversion price. The conversion time is the period from the allotment date of the debentures after which the issuer can exercise its option to convert the securities. The conversion ratio is the number of shares each debenture converts into and may be expressed per bond or on a per centum (per 100) basis. The conversion price is the price at which the debenture holders can convert their debt securities into equity shares. The price is typically more than the current market price of the stock.
The main difference between FCDs and other convertible debentures is that the issuing company of a fully convertible debenture can force conversion into equity, whereas, with other types of convertible securities, the owner of the debenture may have that option. Unlike pure debt issues, such as corporate bonds, fully convertible debentures do not pose a credit risk for the company issuing them since they eventually convert to equity.