Debentures of a Company – Concept, Types, Advantage, Disadvantage

Debentures of a Company – Concept, Types, Advantage, Disadvantage

The word Debenture is driven from the Latin word “debere” which means “to owes a debt”. When a company wants to raise funds on a long-term basis, may borrow money by issue debentures. It is a debt instrument issued by the government or companies to issue the loan. Debentures are issued mainly in the form of a Certificate, given under the seal of the company.

According to the Companies Act, 2013 Section 2(30) define “Debenture includes debenture stock, bonds and any other securities of a Company, whether constituting a charge on the assets of the Company or not.”

A Debenture Certificate includes the term of repayment of the principal sum at a specific date and the terms of payment of interests at a fixed percent.
No company is allowed to issue debentures having a security date of more than 10 years from the date of the issue, however; a company engaged in the infrastructure projects can issue debentures for more than 10 years but not exceeding 30 Years.

Characteristics or Features of Debentures

• It is issued by a company in the form of a Certificate which provides written acknowledgment of debt taken by the company
• It is redeemed after a fixed period of time
• The debentures may be both secured or unsecured
• Debentures provide a fixed rate of interest to debenture holders.
• They are also known as a bond which serves as an IOU between issuers and the purchaser
• It is issued under the seal of the company
• Debenture holders don’t have any voting rights in the company meetings.
• The debentures are issued with a specified rate of interest to the debenture holders which is called the “Coupon rate.”

Difference between Debentures vs Bond

Debenture and bond sound very similar but have different features. Traditionally, bonds had been mainly issued by the government, but now in the modern-day, these are also issued by various semi-government and non-government organizations.

• The main difference between the debenture and bond is concerning the rate of interest.
• Debentures are mainly debt instrument without any collateral security whereas bonds are those loans which are secured by any physical assets.
• The Debenture is issued to debenture holders with a fixed rate of interest whereas bonds can be issued without a pre-determined rate of interest in case of deep discounts bonds or zero-coupon bonds.
• Debentures are issued for the short term needs whereas bonds are an issue for long term investments
• Debentures are high-risk factors as compares to bonds.

Difference between Shares and Debentures

• Share is a part of the capital of the Company whereas debentures is a part of the loan
• Shareholders are known as owners of the company whereas debenture holders are known as creditors of the company.
• Shareholders get dividends from the company whereas debenture holders get interested in the company.
• Shareholders get dividends when the company earns profits, the rate of dividends may fluctuate from year to year depends upon the profits situation of the company and the decision of the directors whereas the debenture holders must be paid irrespective of the company making profit or loss and the rate of interest is fixed.
• The company cannot issue share at a discount according to Section 54 of the Companies Act 2013 except Sweat Equity Shares whereas there are no restrictions on the issue of debentures at a discount
• Shareholders confer the right to participate and vote in company meetings whereas debenture holders neither participate in company meetings and neither possesses any voting rights.

Types or kinds of Debentures_

Secured or Mortgage Debentures

These debentures deal with those debentures which are secured on a particular asset of the company called fixed charges and debentures which are secured on all assets of the company in general, called floating charge. The Fixed charge does not allow the company to deal with the mortgaged assets, whereas the floating charge does not the prevent company from using the assets. If a company is unable to repay the principal or interest amount on the due date, the debenture holders can realize the money from the assets mortgaged with them.

Unsecured or Naked Debentures

These debentures are those which does not deal with the security it means these debentures are not given any security. Unsecured debentures are not secured with a charge of assets. It means the holders of such debentures are treated as unsecured creditors at the time of liquidation of the company.

Registered Debentures

Registered debenture holders are those debenture holders whose names are recorded in the register of the company. It means names and addresses of specific holders whose name is registered on the debenture certificates and such holder names are recorded in a register of the company called “Register of Debenture holders.” Such debentures are not freely transferable. The transfer of these debentures requires the execution of a proper transfer deed.

Bearer Debentures

These debenture holders are those debenture holders whose names are not recorded in the register of the company. It means the names and addresses of such debenture holders are not recorded or registered in a register of the company. These debentures are transferable by mere delivery.

Redeemable Debentures

Redeemable debentures are those debentures that are redeemed at a fixed period or upon demand of the debenture holders. These debentures are those debentures in which either company repaid the lump sum amount to the debenture holders at the end of a specific period or by installments during the lifetime of the Company.

Irredeemable Debentures

Irredeemable debentures are those debentures that are not repayable by the Company during its lifetime. These debentures are repayable only by the Company at the time of liquidation of the company.

Convertible Debentures

These debentures are those debentures that are convertible into equity shares or other securities. These debentures can be divided into two parts:

• Partly Convertible Debentures  In these debentures, only a part of the amount of debenture is convertible into shares.
• Fully Convertible Debentures  In these debentures, the full amount of debenture is converted into shares.

Advantage of Debentures

• Investors who want fixed income at a fixed rate of interest prefer them
• Involve lesser risk
• It provides safety of investment by providing definite security to the investors
• A Cheaper method of raising finance as compare to preference share and equity shares.
• The Company can raise long-term funds with the help of Debentures without the interfere of Debenture holders in Company management.

Disadvantage of Debentures_

• Debenture holders have no voting rights, which mean they cannot interfere in the management of the company.
• It increases the burden of the company like brokerage, commission.
• Due to the nature of Company fluctuating profit, it is not suitable for all type of companies
• The Burden of interest increases at the company at the time of economic Depression and it is difficult for the company to repay the principal and fixed interest.
• Most of the debentures are secures, so the company with less fixed assets cannot raise money through debentures.
• Payment of Debentures is obligatory; hence it is difficult for the company to pay interest at a time when a company is suffering financial crisis.

Author: Divya Tripathi,
Shri Ramswaroop Memorial University LLB 3 Year ( 2 Semester)