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Adebenture is an acknowledgement of debt

or loan, issued by the company under its

seal. Section 2(12) of the Indian Companies

Act, 1956 defines debenture which includes

debenture stock, bonds and other securities of a

company, whether constituting a charge on the

assets of the company or not. The following could

be mentioned in the debenture bond: particulars

relating to the name of the issuing company, nameof the debenture holder, the value of the debenture,

rate of interest payable, time period, charges

created, any other conditions, etc. These are, like

shares, issued for a fixed value. For example, 5000

debentures of Rs 200 each. These too are issued

either at par, or at premium or with discount.

Generally, the procedure of issuing of debentures

is also similar to that of the issue of shares. Though

the value of a debenture can be collected in

instalments, the total amount is collected at thetime of issue of debentures in practice.

The debenture holders are regarded as the

creditors of the company. They are paid interest

at a fixed rate irrespective of the profit earned or

loss incurred by the company. The debenture

amount i.e. principal amount is paid to the

debenture holder on maturity. At the time of

liquidation of the company, debenture holders

are paid back their capital first.

Characteristics of Debentures

Claims on Incomes: Debenture holders have a

priority of claim to income over shareholders. For

protecting their claim to income, they may even

put restrictions on dividend payments to

shareholders. Another aspect of claim to income

is its certainty. The debenture holders claim to

Debentures made easy!income is fixed and certain and the company

under a legal obligation, has to pay it in cash

regardless of companys earnings. However, they

do not have the right to share in the profits of the

company.

Claims on Assets: Debenture holders have a

priority over shareholders in respect of their claim

on assets. However, such claims arise only in theevent of liquidation or reorganisation of the

company. To insure against risk of loss of principal

amount, debenture holders prefer to have loan

secured by a charge or lien on specific assets.

Their claim on assets is equivalent to the face

value of debentures, the holders possess. They

do not have any claim on residual assets.

Maturity: Unlike shares, debenture holders will be

paid back the principal amount at a definite timealready stipulated on the debentures. The

debentures, which have fixed maturity date and

are repayable in cash, are called redeemable

debentures and others, which have no maturity

date, are called irredeemable or perpetual bonds.

Controlling Power: Debenture holders do not

have any voting right for electing the directors

and for determining important managerial policies

and consequently, no controlling power.However, in the event of default of payment of

interest or principal amount, the debenture

holders may take recourse to law.

Kinds of Debentures

Secured Debentures: Secured debentures are

secured by some charge on the assets of the

company. The charge may be fixed or floating.

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ECOFUNDASFORYOUThe assets of the company on which charge is

created cannot be sold under normal

circumstances. If at all they are sold, the amountrealised should be exclusively used to repay the

interest and principal amount to the secured

debenture holders.

Unsecured Debentures: In case of unsecured

debentures, no charge is created on the assets of

the company. The holder of such debentures is

just like any other ordinary creditor of the

company.

Registered Debentures: These debentures are

registered in the debenture holders register of

the company. The payment of regular interest as

well as the principal amount on maturity will be

made to the person whose name appears in the

register. As in the case of shares these are

transferable and every transfer is recorded and

registered.

Bearer Debentures: These debentures are

transferable by mere delivery. The company isneither informed about their transfer nor does the

company records any such transfer. These are

similar to share warrants and interest is paid to

the holder of these documents on production of

interest coupons which are attached to them.

Redeemable Debentures: In case of redeemable

debentures, the principal amount is paid back

either on a fixed date or upon demand or notice.

Irredeemable Debenture: In this case, the issuing

company does not fix any date by which they

should be redeemed and the holders of such

debentures cannot demand payment from the

company, so long it is a going concern. These are

also called as perpetual debentures as they are

repayable after a long period of time or at the time

of winding up of the company.

Merits

For Debenture holders

Risk-averse investors can invest indebentures, which are a safe-bet.

Irrespective of the profit and loss positionof the company, they will be paid interest at

regular intervals and the principal amount

on maturity.

In case of secured debentures, theinvestment is fully secured.

For Company

Interest paid on debentures is comparativelylower than the dividend to equity

shareholders. Thus, it is economical.

On account of reduction in the overall capital,the profitability of the company will increase

and equity shareholders will gain

additionally.

Use of debentures is in conformity with the

wealth maximisation objective of thecompany.

Since, debenture holders do not have votingpower, the controlling power of the company

will not get diluted.

Demerits

It is very risky to use / hold debentures, whenthe company fails to earn stable profits.

Use of debentures may lead to insolvencyof the company, when it is not making

adequate profits.

Company cannot mobilise capital when itowns no assets to offer as security.

It is not desirable to use debentures as a source

of capital when the rate of return is less than the

cost of debt capital.