Debentures – Concept, Types, Advantages, Disadvantages

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What are the different types of companies?

Debentures – Concept, Types, Advantages, Disadvantages

The company has the power to borrow as authorized by the articles of the company, which can be only exercised by the directors of the company in a duly convened meeting. In order to run a company smoothly and efficiently, adequate capital is a prerequisite which can be arranged through internal sources like Issuing Equity Share Capital or external sources like borrowing. Thus, borrowing is a mechanism to which a company resorts to fulfill its capital needs with an expressed or implied consent to return back the money.

What is a Debenture?

In general, debenture is an instrument which acknowledges debt a company owes to the borrower.

As per Sec 2(30) of the Companies Act, 2013,

“Debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Further provided that,

  1. the instruments referred to in Chapter III-D of the Reserve Bank of India Act, 1934; and such other instrument, as may be prescribed by the Central Government in consultation with the
  2. Reserve Bank of India, issued by a company,

shall not be treated as a debenture.

Debenture vs. Bond

  1. Collateral Requirement

Debentures are debt instruments without any collateral security.

Bonds are essentially loans that are secured by any physical assets.

  1. Tenure

Debentures are essentially short term borrowings borrowed in accordance of the company needs.

Bonds are long term investments with a long tenure.

  1. Risk factor

Debentures are covered by high risk factors without any backing of collateral.

As compared to debentures, bonds are a safe game to invest in because of the backing of collateral security and periodical scrutiny of the credit rating agencies.

  1. Convertibility to shares

Convertible debentures can be converted into shares.

Bonds cannot be converted into any type of shares.

  1. Priority on Winding Up

While the company is in the event of liquidation, bondholders are casted upon priority over debenture holders.

Debentures vs. Shares

  1. Meaning

Debenture comprises loan of the company

Shares constitute the capital raised by the company.

  1. Interest vs. Dividend

Debenture holders get fixed interest which is given priority over dividend issued by the company.

Shareholder gets dividend in consonance with the profits made by the company during the financial year.

  1. Issue at discount

There are no restrictions for debentures to be issued at a discount.

Whereas, shares are cannot be issued at discount as per Section 54 of the Companies Act 2013.

  1. Charge on the Assets

Debentures carry a charge on the assets of the company.

Shares do not come up with charges on the assets of the company.

Nature of Debentures

Debentures are movable property which will be transferrable as mentioned in the Articles of Association of the Company under Section 44 of the Companies Act, 2013.

As per Section 56 of the Companies Act, 2013, the debentures are to be transferred vide form no. SH-4.

Features of Debentures

  1. A debenture is a smallest unit of a loan.
  2. When debentures are issued by the company, a Debenture Certificate is issued to the holders indicating the amount lent by the company.
  3. Until the full debentures are redeemed by the company, the company has the liability to pay a periodic interest over the debentures.
  4. No voting rights are granted to the debenture holders as per mentioned in Section 71(2) of the Companies Act, 2013.
  5. A debenture may be both secured and unsecured. In case of secured debentures, a charge is created on the assets of the company in favour of debenture trustee.

Types of Debentures

On the basis of security

Secured Debentures

These kinds of debentures are secured with a charge on the fixed assets of the company issuing debentures thus failing to pay the principal or interest amount, the assets fixed can be sold to repay the liability of the debenture holders.

Unsecured Debentures

Unsecured debentures are issued by the company without any creation of charge on the assets. As a result if the company does not pay principal amount on due date the debenture holders cannot claim the payment through he assets of the company.

On the basis of convertibility to shares

Partly Convertible Debentures

These debentures can be converted into equity shares only part of it at the issuer’s notice according to the ratio.

Nonconvertible Debentures

These debentures cannot be converted into equity shares thus being consistent with its debt character.

Fully Convertible Debentures

These debentures are fully convertible into equity shares at the conversion rate of the issuer.

Optionally Convertible Debentures

The investor has the option at his discretion to convert the debentures into equity shares as agreed upon.

On the basis of redeemability

Redeemable Debentures

This kind of debenture will be redeemed at a fixed date or upon demand, or after notice or under a system of periodical drawings which is predetermined previously on an issue.

Irredeemable Debentures

In this kind of debentures, the debenture holder cannot  demand back the principal amount till the company is a going concern.

On the basis of Registration of Instrument

Registered Debentures

Registered Debentures are issued out in the name of a specific person whose name appears on the debentures certificate and on the Register of Debenture Holders as the debenture holder.

Bearer Debentures

Debentures which are made out to a bearer are bearer debentures which are negotiable instruments and are transferrable through delivery as share warrants.

Advantages of Debentures

  1. Fixed rate of return

The debentures give the investors a fixed rate of interest irrespective of the profits made by the company.

  1. Availability of Funds

Raising money through issue of equity and preference shares is quite intricate and lengthy process whereas debentures can be easily raised as compared to shares.

  1. Non-interference in the management

The debenture holders cannot interfere in the internal affairs of the company thus less meddling in the governance.

  1. Market Response

The debentures are easily disposable in the open market thus giving a satisfactory response.

Disadvantages of Debentures

  1. Permanent Liability

The burden of interest on the company to give periodical and timely payments would be perpetual till the debentures are redeemed.

  1. A limit in Company’s Credit

The credit worthiness of the company falls as there are charges secured on the assets of the company thus hampering the value of the company in the market making it difficult to raise capital from borrowings.

  1. Not suitable for all Companies

Due to the nature of company’s fluctuating profits, it is not suitable for the company as it may turn difficult to repay principal amount and interest in times of economic depression.

BIBLOGRAPHY

  1. https://www.icsi.edu/media/webmodules/FinalCompanyLawBook22092020.pdf
  2. https://accountlearning.com/debentures-meaning-issue-features-types-advantages-disadvantages/
  3. https://resource.cdn.icai.org/61979bos50391mod1-cp4.pdf
  4. https://www.accountingnotes.net/debentures/debenture-advantages-and-disadvantages/8083

Author: Aathira Pillai,
Dr. D.Y. Patil College of Law, BLS LLB 4th year

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