Fully Convertible Debentures (FCDs) are debt instruments issued by companies that must be converted into equity shares after a specific period. These financial tools work like regular debentures earning interest, but later transform into company shares based on pre-set conversion terms and ratios.
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What Is Fully Convertible Debentures?
A Fully Convertible Debenture (FCD) is a debt security that companies issue to raise funds, which converts into equity shares after a set period. FCDs start as debt instruments paying regular interest to investors but eventually transform into company shares at pre-decided conversion terms.
FCDs serve as a strategic financial tool benefiting both companies and investors. Companies use FCDs to delay equity dilution while managing their debt obligations through scheduled interest payments. The conversion terms, including price and timing, are set when the debentures are issued. Investors earn regular interest income during the debenture period and can later become shareholders. The conversion of FCDs into equity shares happens at a predetermined time, with the conversion price typically set higher than the market price at issuance.
Features of Fully Convertible Debentures
The main features of Fully Convertible Debentures include their conversion to equity shares at a preset time and price. These debt instruments pay regular interest until conversion and help companies raise funds without immediate equity dilution, while offering investors both debt and equity benefits.
- Fixed Conversion Terms: Companies set specific conversion terms at the time of FCD issuance. This includes the conversion price, which is usually higher than the current market price, and the exact timeline for conversion. These terms remain unchanged throughout the debenture period and protect both the company and investors from market uncertainties.
- Interest Payment Structure: FCDs pay interest at fixed intervals until their conversion into equity shares. The interest rates are typically higher than regular bank deposits to attract investors. Companies must maintain these interest payments regardless of their financial performance, making them a reliable income source for investors.
- Regulated Framework: SEBI strictly regulates FCD issuance in India. Companies must meet specific criteria and follow guidelines about disclosure requirements, credit rating, and trustee appointment. This regulatory framework ensures transparency and protects investor interests throughout the debenture’s lifecycle.
- Trading Flexibility: Investors can trade FCDs on stock exchanges before conversion, similar to regular shares. This provides liquidity and exit options for investors who don’t want to wait until the conversion date. The market price of FCDs often reflects both the interest component and potential equity value.
- Capital Structure Impact: FCDs initially appear as debt on the company’s balance sheet but move to equity after conversion. This transition helps companies improve their debt-to-equity ratio over time. The delayed equity dilution gives companies time to utilize funds and potentially improve share value before conversion.
Benefits Of Fully Convertible Debentures
The main benefit of Fully Convertible Debentures lies in their dual advantage for both companies and investors. Companies get funds without immediate equity dilution, while investors receive fixed interest income initially and later gain potential equity appreciation through share ownership.
- Cost-Effective Fundraising: Companies save on immediate share dilution costs and can secure funds at lower interest rates compared to regular loans. The delayed equity dilution helps maintain current shareholding patterns while providing necessary capital. This makes FCDs an attractive option for companies looking to expand or fund new projects.
- Tax Advantages: Interest payments on FCDs qualify as tax-deductible expenses for companies, reducing their tax liability. For investors, the interest earned is taxed at their applicable slab rates. After conversion, any capital gains from selling the shares get taxed under more favorable capital gains tax rates.
- Portfolio Diversification: Investors gain exposure to both fixed-income and equity investments through a single instrument. The initial interest payments provide stable returns, while the later equity conversion offers growth potential. This combination helps investors build a balanced investment portfolio with controlled risk.
- Market Opportunity: Investors can benefit from potential stock price appreciation before and after conversion. If the company performs well, the conversion price fixed at issuance might be lower than the market price at conversion time. This price difference creates immediate gains for debenture holders.
- Strategic Growth Planning: Companies can plan their expansion with assured funds while delaying shareholder dilution. The fixed conversion terms help in better financial planning and resource allocation. This structured approach gives companies time to utilize funds effectively before the equity conversion kicks in.
Disadvantages Of Fully Convertible Debentures
The primary disadvantage of Fully Convertible Debentures centers on the mandatory conversion to equity shares, which can create uncertainty for both companies and investors. Companies face future equity dilution, while investors might get shares at unfavorable prices regardless of market conditions.
- Compulsory Interest Payments: Companies must pay regular interest on FCDs regardless of their financial health or market conditions. This fixed payment obligation can strain cash flows during tough business periods. Unlike equity dividends which companies can skip, FCD interest payments remain mandatory until conversion.
- Market Risk: The conversion price fixed at issuance might turn unfavorable if market conditions change significantly. Investors risk receiving shares at higher than market prices during conversion. Similarly, companies might have to issue more shares than originally planned if their stock price falls substantially.
- Limited Exit Options: Investors cannot withdraw their investment before the conversion date unless they sell FCDs in the secondary market. The secondary market for FCDs often lacks liquidity, making it difficult for investors to exit their positions when needed. This lock-in period can be problematic during financial emergencies.
- Complex Valuation: Determining the fair value of FCDs becomes challenging due to their hybrid nature. The valuation must consider both debt and equity components, making it difficult for investors to make informed decisions. This complexity often leads to pricing inefficiencies in the secondary market.
- Future Earnings Dilution: Companies face certain equity dilution at conversion, which affects future earnings per share. This dilution might disappoint existing shareholders and impact stock prices. The increased number of shares also means spreading future profits among more shareholders.
Types Of Convertible Debentures
The main types of Convertible Debentures crucial for corporate financing are Partially Convertible Debentures (PCDs) and Fully Convertible Debentures (FCDs). Each type of debentures offers distinct conversion features that help companies raise funds while providing investors with different investment opportunities.
- Fully Convertible Debentures (FCDs): These debentures completely convert into equity shares at a predetermined time and price set during issuance. Companies pay regular interest until the conversion date, after which investors become shareholders. FCDs help companies manage cash flow by delaying equity dilution while giving investors fixed returns and future equity ownership.
- Partially Convertible Debentures (PCDs): PCDs divide into two portions – a convertible part that changes to equity shares and a non-convertible part that stays as debt. The non-convertible portion continues earning interest until maturity, when companies repay the principal. This structure lets investors enjoy both debt security and equity participation.
Fully vs Partially Convertible Debentures
The main difference between FCDs and PCDs lies in their conversion structure. FCDs convert entirely into equity shares at a predetermined time, while PCDs split into two portions – one part converts to equity shares, and the other remains as debt until maturity with regular interest payments.
| Parameter | Fully Convertible Debentures (FCDs) | Partially Convertible Debentures (PCDs) |
| Conversion Process | Complete conversion to equity shares in one go | Split into convertible and non-convertible portions |
| Risk Level | Higher risk as entire investment converts to equity | Moderate risk due to balanced debt-equity structure |
| Interest Payments | Interest payments stop after conversion | Continues on non-convertible portion till maturity |
| Investment Return | Complete equity exposure after conversion | Mix of debt and equity returns |
| Capital Structure Impact | Full equity dilution after conversion | Partial equity dilution with some debt remaining |
| Maturity Period | Ends with equity conversion | Continues for non-convertible portion |
Fully Convertible Debentures Meaning – FAQs
Fully Convertible Debentures (FCDs) are debt instruments that must convert into equity shares after a specific period. These instruments initially pay interest to investors and later transform into company shares at predetermined conversion terms.
No, FCDs cannot be redeemed since they must convert to equity shares. Unlike regular debentures, FCDs don’t offer repayment of principal amount as they automatically change into company shares at the set conversion time.
FCDs carry moderate risk as they combine features of debt and equity. While they offer secured interest income initially, the final value depends on the company’s share price during conversion, making them suitable for informed investors.
The main types are Fully Convertible Debentures (FCDs) that completely convert to shares and Partially Convertible Debentures (PCDs), where only a portion converts while the rest remains as debt with interest payments.
Yes, companies can issue FCDs after meeting SEBI’s regulatory requirements. They must have a good credit rating, appoint trustees, and provide detailed disclosure documents about conversion terms and company financials.
Optionally Fully Convertible Debentures give investors the choice to convert their entire investment into equity shares. If they are not converted, they continue as debt instruments paying regular interest until maturity.
The main difference between FCDs and PCDs is that FCDs convert completely into equity shares, while PCDs split into two parts – one converts to shares while the other remains as debt paying regular interest.
