Debentures are long-term debt instruments that companies issue to borrow money from the public. Debentures are similar to bonds, but they are not secured by specific assets of the company. Instead, they are backed by the general creditworthiness of the company. Debenture holders are creditors of the company and have no voting rights.
The process of issuing and redeeming debentures is an important aspect of corporate finance. Here is a detailed explanation of the issue and redemption of debentures:
Issue of Debentures:
The issue of debentures involves the following steps:
- Authorization: The first step in issuing debentures is to get authorization from the board of directors and shareholders. The board of directors must pass a resolution authorizing the issuance of debentures, and shareholders must approve the resolution.
- Prospectus: After getting authorization, the company must prepare a prospectus that provides details about the debentures, such as the terms and conditions, the interest rate, and the maturity date.
- Subscription: The prospectus is then circulated among potential investors who can subscribe to the debentures. Investors who wish to subscribe to the debentures must fill out an application form and pay the subscription money.
- Allotment: Once the subscription period is over, the company will allot the debentures to the investors who have subscribed to them. The allotment of debentures is done based on the terms and conditions specified in the prospectus.
- Issue of Debenture Certificates: The company must then issue debenture certificates to the allottees. The debenture certificates contain details such as the name of the holder, the amount of the debenture, the interest rate, and the maturity date.
Redemption of Debentures:
The redemption of debentures involves the following steps:
- Call Notice: The company must issue a call notice to the debenture holders informing them of the date on which the debentures will be redeemed. The call notice must be sent at least three months before the redemption date.
- Creation of Redemption Reserve: The company must create a redemption reserve by transferring a certain amount of money to a separate account every year. The purpose of this reserve is to ensure that the company has enough funds to redeem the debentures on the maturity date.
- Payment of Redemption Amount: On the maturity date, the company must pay the redemption amount to the debenture holders. The redemption amount includes the principal amount and any interest due on the debentures.
- Cancellation of Debentures: After the redemption amount has been paid, the company must cancel the debentures and update its books of accounts.
Pros and Cons of Issuing Debentures:
Pros:
- Lower Cost of Capital: Debentures offer a lower cost of capital than equity as the interest paid on debentures is tax-deductible.
- No Dilution of Ownership: Issuing debentures does not dilute the ownership of existing shareholders.
- Fixed Obligation: The interest and principal payments on debentures are fixed, which makes it easier for companies to plan their cash flows.
- No Voting Rights: Debenture holders have no voting rights, which means that the company’s management retains control.
Cons:
- Cost of Redemption: The redemption of debentures involves a cost to the company in terms of paying the redemption amount to the debenture holders.
- Reduction in Liquidity: The redemption of debentures reduces the liquidity of the company as it has to pay a large amount of money to the debenture holders on the date of redemption.
- Impact on Credit Rating: The redemption of debentures can have an impact on the credit rating of the company as it reduces the amount of debt in the company’s capital structure.
- Reduction in Tax Shield: The interest paid on debentures is tax-deductible, which reduces the tax liability of the company. The redemption of debentures reduces the amount of interest paid and, therefore, reduces the tax shield.