2. An Overview
According to Thomas Evelyn “ A debenture is a document
under the company’s seal which provides for the payment of a
principle sum and interest thereon at regular intervals, which is
usually secured by a fixed or floating charge on the company’s
property or undertaking and which acknowledges a loan to the
company.” A debenture holder is a creditor of the company. A
fixed rate of interest is paid on debentures. The interest on
debentures is a charge on the profit and loss account of the
company. The debentures are generally given a floating charge
over the assets of the company.
3.
4. FEATURES
• Date of Maturity: For all the non convertible and redeemable
debentures, the issuing company has to issue repayment to the debenture
holders on the date of maturity. This date is also mentioned on the
certificates and it infers the total time for which the money is invested by
the lenders which is interval between the date of issue to the date of
maturity.
• Charge on Assets and Profits in case of Default: The debenture
holders may have claims over the profits and assets of the company in
case the company has defaulted in the payment of either the interest or
the capital repayment.
• Convertibility: Certain types of debentures are issued with the option
of conversion into equity. The ratio of conversion and the time period
after which conversion will take place is mentioned in the agreement of
debenture. Debentures may be fully or partly convertible in nature.
5. FEATURES(CONT’D)
• Debenture holders are not the owners of the company. They are
considered the creditors of the corporation or in other words, the
company borrow money from them through issuing debenture.
• No voting rights: The debenture-holder is not a shareholder and
cannot vote in the company's general meetings.
• Fixed rate of interest: A debenture with a fixed charge has a fixed rate
of interest. It can be presented as "10% Debenture". They are always
unsecured and earns a fixed rate of interest but has no share of the profit.
• Control: Since, debentures holders are creditors of the company and
not its owners, they do not have any control over the management of the
company. They do not have any voting rights to elect the directors of the
company or on any other matters. But, at the time of the liquidation of
the company they have prior claim over share holders and if remain
unpaid, they may take control over the company.
7. Security:
• Secured/Mortgage Debentures: Debentures secured against assets
of the company .i.e. if the company is winding up, assets will be sold
and debenture holders will be paid back. The charge/mortgage may
be fixed or a floating charge. If it is fixed, charge is on a specific
asset say plant, machinery etc. If it is floating charge, it means it is
on general assets of the company.
Which assets are charged: The ones available with the company
presently and also assets in future.
• Unsecured/Naked Debentures: Debentures not secured against
assets of the company .i.e. if the company is winding up, assets will
be not be sold in order to pay the debenture holders. In other
words, no charge is created on the assets of the company which
means that there is no security of interest and principal payment. The
creditworthiness and soundness of the company serves as a
security.
8. Tenure:
• Redeemable Debentures: Debentures which have to be repaid within
a certain specified period.
E.g.: 5% 2 years Rs. 1000 debenture means redeemable period is 2
years(5%:interest/coupon payment). After redemption, they can be
reissued.
• Irredeemable/Perpetual Debentures: These can be paid back at any
time during the life of the company .i.e. there is no specified period for
redemption. Hence they are also called Perpetual Debentures.
Nonetheless if the company has to wind up, then they have to repay the
debenture holders.
9. Registration:
• Registered Debentures: As the name suggested, these are debentures
that are registered with the company. It records all details of debenture
holdings such as name, address, particulars of holding
etc. Interest shall be paid only to the registered holder (treated as a non-
negotiable instrument). They can be transferred by a transfer deed.
• Bearer Debentures: These can be transferred by mere delivery.
Company does not hold records for the debenture holder. Interest will
be paid to the one who displays the interest coupon attached to the
debenture.
10. Coupon:
• Zero Coupon Debentures: Does not have a specified interest rate,
thereby to compensate, they are issued at a substantial discount. Interest:
Difference in face value and issue price.
• Specific Coupon rate Debentures: Debentures are normally issued
with an interest rate which is nothing but the coupon rate. It can be fixed
or floating. Floating is associated with the bank rates.
Convertibility:
• Convertible Debentures (Fully/ Partly convertible): Debentures which
can be converted to either equity shares or preference shares by the
company or debenture holders at a specified rate after a certain period. A
company can also issue Partly Convertible Debentures whereby only a
part of the amount can be converted to equity/preference shares.
• Non Convertible Debentures (NCDs): These can’t be converted into
equity/preference shares.
11. SHARES DEBENTURES
1. A shareholder is the owner of the
company.
1. Whereas, Debenture holder is a
creditor of the company and cannot take
part in the management of the company
2. Shareholder will get a portion of the
profits called dividend which is
dependent on the profits of the company.
It can be declared by the directors of the
company out of profits only.
2. Debenture holders will get interest on
debentures and will be paid in all
circumstances, whether there is profit or
loss will not affect the payment of
interest on debentures.
3. Shares cannot be converted into
debentures.
3. Whereas debentures can be converted
into shares.
4. There can be no mortgage shares.
Assets of the company cannot be
mortgaged in favor of shareholders.
4.But, there can be mortgage debentures
i.e. assets of the company can be
mortgaged in favor of debenture holders.
5.At the time of liquidation of the
company, share capital is payable after
meeting all outside liabilities.
5.Debentures are payable in priority
over share capital.
Shares V/S Debentures
12. Advantages/Merits of Debenture Issue:
• It enables a company to raise funds for a specific period.
• No dilution of control as debenture holders don’t possess voting rights
• Debenture (debt) enables the company to Trade on equity. It can pay
dividend to equity shareholders at a rate higher than overall ROI.
• Debenture holders entitled to a fixed rate of interest. E.g.: 10% debenture
• They enjoy priority over other unsecured creditors with respect to debt
repayment.
• Suitable for conservative investors who seek steady ROI with little or no
risk.
• Interest on debentures is treated as expense and is tax deductible.
• Company can adjust its gearing in accordance to its financial plan.
• Debenture holders are regarded as creditors of the company and they
receive preference over equity shareholders and preference share holders.
• Opting for debentures over the equity as a source of finance saves the
profit shares of existing shareholders. Debenture holders do not share
profits of the company. They are liable to receive the agreed amount of
interest only.
13. Disadvantages/Demerits of Debenture issue:
• They have a fixed maturity; hence provision has to be made for repayment.
• There is a limit to which funds can be raised through debentures.
• It is risky if the company fails to pay interest or principal installment on
time, as debenture holders can file petition for winding up the company.
• It is not suitable for a company with fluctuating earnings as it may also lead
to fluctuations in payment of dividend payable to equity shareholders.
• With more risk, you get more return. Debentures being secure investments,
returns are less.
• Like ordinary shares, debenture holders will not be regarded as owners of
the company and have no voting rights.
• Debenture financing enhances the financial risk.
• Debentures are a secured source of raising the long term requirements of
funds and usually the security offered to the investors is the fixed assets of
the company.
• Common people cannot buy debenture as they are of high denominations.
