Professional Documents
Culture Documents
PROJECT
DEBENTURES
Intr
ABSTRAC o
T
“Any informed borrower is simply less vulnerable to fraud and abuse”-
Alan Greenspan
Being a qualified Company Secretary, it was an interesting task to take up
topicsfrom corporate world. Having worked under various circumstances,
one thing wasclear that a project shall be based on some real time
experiences that author hasfaced during her professional tenure. The
concept of debenture struck in mind of author because she has seen that
there is a lack of organized debt market in India and also, during her work
experience, she has faced some challenges in legal compliance in issuing
and listing of long term debt instruments: Debentures
INTRODUCTI
ON
Finance is the lifeblood of every business. It is perhaps the most crucial factor in deciding fate of any business enterprise. Finance is required in day-to-day transactions of
business as well as for carrying out capital (long term) investments of the business. Keeping this in view, it is the most important function of a financial manager that is to
arrange funds for the business from different sources. This becomes necessary under the fact that pre determined goals of business could only be achieved when a business
does not suffer from lack of finance. It is evident in daily lives too that a person cannot carry on his daily tasks without having financial support.
CAPITAL
Equity Capital:
STRUCTURE
Shareholders' equity (or stockholders' equity, shareholders' funds,shareholders' capital employed) is the interest in remaining assets,
spread among individualshareholders of common or preferred stock. At the start of a business, owners put some fundinginto the
business to finance assets. Businesses can be considered to be, for accounting purposes,sums of liabilities and assets; this is the
accounting equation. After liabilities have beenaccounted for, the positive remainder is deemed the owner's interest in the busi n ess.
Preference Capital:
Preferred stock, also called preferred shares or preference shares, istypically a 'higher ranking' stock than voting shares, and its terms
are negotiated between thecorporation and the investor. Preferred stock usually carries no voting rights, but may carrysuperior priority
over common stock in the payment of dividends and upon liquidation. Preferredstock may carry a dividend that is paid out prior to any
dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock.
Preferredstockholders will be paid out in assets before common stockholders and after debt holders in bankruptcy. Terms of the
preferred stock are stated in a "Certificate of Designation".
Debt Capital:
Debt capital is the capital that a business raises by taking out a loan. It is a loanmade to a company that is normally repaid at some
future date. Debt capital differs from equityor share capital because subscribers to debt capital do not become part owners of the
business, but are merely creditors, and the suppliers of debt capital usually receive a contractually fixedannual percentage return on
their loan, and this is known as the coupon rate.Debt capital ranks higher than equity capital for the repayment of annual returns. This
means thatlegally, the interest on debt capital must be repaid in full before any dividends are paid to anysuppliers of equity.
Debentures: Meaning and
Nomenclature:
A debenture is defined as a certificate of agreement of loans which is given under the company'sstamp and carries an undertaking that the debenture holder will get a fixed
return (fixed on the basis of interest rates) and the principal amount whenever the debenture matures.In finance, a debenture is a long-term debt instrument used by
governments and large companiesto obtain funds. It is defined as "a debt
secured only by the d
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Funds raised by the company by way of debentures are required to be repaid during the life time of the company at the time stipulated by
the company. As such, debenture is not a source of permanent capital. It can be considered as a long-term source
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The interest on debenture is payable even if the company does not earn the profits
and more. and more.
Chapter
Classification of 1
debentures
In India, debentures could be classified in basically two categories: on the basis of security
andon the basis of convertibility. The following diagram shows details of classification of
debentures in Indian context:
Classification Of Debentures On the basis Conversation the basis Of Security
Fully Convertible Partly Convertible Non-Convertible Secured Debentures Unsecured
Debentures Optionally Convertible
On the basis of convertibility:
Secured Debentures:
These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of either the principal or interest amount, his assets can
be sold to repay the liability to the investors.
Unsecured Debentures:
These instruments are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to
belong with other unsecured creditors of the company . Along the dimension of security, we have seen that debentures have been classified into unsecured(Straight) and
secured (mortgage) debentures. Unsecured debentures do not carry any charge on specific assets of the company while secured debentures carry a fixed or floating charges
on assets of company.
ADVANTAGES Chapter 2
OF
DEBENTURES
Debentures are considered a more secure investment than purchasing shares. This is because the company must pay interest on the debenture before any dividends can be paid
to shareholders.
Reduced cost of capital
Secure investment
The cost of issuing equity is higher than the cost of debt. Debentures are a long-term commitment, usually 7 to 10 years or more, which gives the company time to meet its
commitment.
Long-term funding
Debentures can encourage long-term funding to grow a business. Cost-
effective
Debentures are cost-effective when compared with other forms of lending. They generally provide a fixed rate of interest for the lender, and this has to be paid before any
dividends are issued to shareholders.
Lower interest rates
Debentures carry lower interest rates and longer repayment dates than other types of loans and debt instruments. Liqu id
Debentures are liquid and can be traded on the stock exchange. F le xib
ilit y
Bearer debentures offer a high level of flexibility to investors. Since there is no record of ownership, the holder of the debenture can easily transfer it to another investor
without having to go through any formal registration process.
Less risky
A debenture can be less risky than preferred shares but will also typically have a lower expected return.
DISADVANTAGES
OF DEBENTURES
Interest payments
Companies are required to pay interest on debentures regardless of their financial performance. This can strain financial resources, especially in years with reduced
profitability or losses.
Inflationary risk
Redeemable debentures often offer a lower coupon rate than other fixed-income instruments. This can reduce a portfolio's earning potential and create inflationary
risk if the interest rate doesn't keep up with inflation.
Less control over assets
If the debenture is secured, the business may not be able to sell certain assets.
No voting rights
Debenture holders are not allowed to vote or share in profits.
Not a good investment in low inflation
Debentures may not be a good investment choice in low inflationary periods.
Legal Compliances
Here are some legal compliances related to debentures:
•Debenture Redemption Reserve
•Companies must create a Debenture Redemption Reserve within 12 months of issuing debentures. If they don't,
they must pay a 2% interest penalty to debenture holders.
•Debenture holders
2 •Debenture holders can't vote in the company's general meetings of shareholders, but they can have separate
meetings to vote. They are eligible for a fixed rate of interest.
•Debenture conversion
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teither wholAly dodr paa mrtalyin, apt otihnet time of
redemption. This issue must be approved by a special resolution at a general meeting.
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Debenture Redempotin
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to financial institutions,commercial banks, mutual funds and board of directors of that particular company. A
secretarial professional often finds himself in a dilemma when such kind of case comes before him. In mostoften
cases, a Company Secretary has to resort to bare acts-, which is indeed a tedious task in itsown self.
Some of the provisions that are to be followed while making issue of debentures, in case of a private company are listed as follows:
1) A private company cannot issue unsecured debentures:
Under the Companies(Acceptance of Deposit) Rules, 1975 “any amount raised by issue of debentures (includingconvertible debentures) secured by the mortgage of
any immovable property of the company andthat the market value of the immovable property secured is higher than the amount of debenturesissued” is not considered
to be a Deposit. Under Section 3(1)(d) of the Act,
a Private Company is prohibited from accepting Deposit from persons other than its Directors, Members and their
relatives. Hence, the Private Company must issue Debentures only as a Secured Debenture
.
2) Approvals to be taken before proceeding for the issue:
Board for issue of Debentures under Section 292(1)(b). Board Creation / Declaration of Trust: Board Appointment of Debenture Trustees(Section 117B) Board
Approval of Draft Trust Deed.Board Approval of the Form of Debenture Certificate. Letter from
Trustees Consent from the Debenture Trustees to act as Trustees. No approvals are required to be obtained under Section 293(1)(a) Some of the provisions that are to be
followed while making issue of debentures, in case of a private company are listed as
follows:
and (d) since, theSection does not apply to Private Limited Companies, unless it is a Subsidiary of a PublicCompany.
3) Allotment:
Since, the Company proposes to place the Debenture privately, it is suggestedthat a Letter of Offer is also made which would be
circulated amongst the target buyers. Thedraft letter of offer is also required to be approved by the Board. The conditions relating to
the payment for subscription, the Security, the rate of interest on the Debentures and the period bywhich the Debentures would be
The security is to be created by way of Equitable Mortgage by wayof deposit of title deeds of the immovable property of the
Company. The deposit is required tomade with the Trustees. The procedure relating to this is as follows: