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Sunday, May 11, 2014

Debentures: Meaning, Characteristics and Types

Meaning of Debentures
According to Sec. 2 (12) of the companies Act, 1956, debentures include “debenture stock, bonds and any other securities of a company”.

Debentures are debt instruments issued by a joint stock company. Amounts collected by way of debentures form part of the loan capital of a company. They are repayable after a fixed period. Debenture holders get interest on their debentures. They are creditors of the company. They do not get dividend. Only shareholders get dividend.

The characteristics of debentures can be summarised as follows:
a)      Debentures are debt instruments.
b)      They generally carry fixed rate of interest.
c)       They are normally repayable at the end of a fixed period. Repayment of debenture or cancellation of debenture liability in the books of the company is known as redemption of debentures.
d)      They can be issued at par, premium or at discount depending on the reputation of the company.
e)      They can either be placed privately or offered for public subscription.
f)       They may or may not be listed in the stock exchange.

g)      If offered for public subscription, they should be rated by a credit rating agency approved by SEBI, prior to listing.
h)      Interest is payable on debentures at a fixed rate irrespective of the profit earned by the business.
i)        Debentures may be issued with or without the security of assets of the company.
j)        In the event of winding up of the company the debenture holders are treated as creditors and given priority in repayment of their money.
k)      Debenture holders normally do not have representation in the Board of the company.

Types of Debentures
Debentures are classified as follows:
1. On the Basis of Repayment
a. Redeemable Debentures: These debentures are paid off or redeemed after the prescribed period.
b. Irredeemable or Perpetual Debentures: These debentures are permanent debentures of a company. They are paid back only in the event of winding up of a company.

 2. On the Basis of Transferability
a. Registered Debentures: These are debentures for which the company maintains record of debenture holders. Therefore when such debentures are sold or transferred it should be intimated to the company for making change in the register of debenture holders.
b. Bearer Debentures: These debentures are transferable by mere delivery. There is no need or registration of transfer with the company.

 3. On the Basis of Security
a. Simple or Naked Debentures: These are debentures not secured by any asset of the company. If the company goes into liquidation these debentures are treated as unsecured creditors.
b. Mortgage Debentures: Mortgage debentures are issued on the security of certain assets of the company. They can be secured by fixed assets or floating assets of the company.

4. On the basis of Conversion
a. Convertible Debentures: These debentures are issued with an option to debenture holders to convert them into shares after a fixed period. Convertible debentures are either partially convertible debentures or fully convertible debentures.
b. Non Convertible Debentures: These are debentures issued without conversion option. The total amount of the debenture will be redeemed by the issuing company at the end of the specific period.

5. On the Basis of Pre-Mature Redemption Rights:
a. Debenture with “Call” option: A callable debenture is one in which the issuing company has the option of redeeming the security before the specified redemption date at a pre-determined price.
b. Debenture with “Put” option: This is a debenture in which the holder has the option of getting it redeemed before maturity.

6. On the Basis of Coupon Rate (interest rate)
a. Fixed Rate Debentures: Most of the time debentures are issued with a prefixed rate interest. These debentures are called fixed interest debentures
b. Floating rate Debentures: Floating rate as the names suggests keeps changing.
c. Zero Coupon Bonds: These are debentures issued with no interest specified. They are issued at a substantial discount to compensate the investors. These bonds are known as deep discount bonds.

Difference between Shares and Debentures
Basis of Difference
1. Ownership
Shareholders are the owners of the Company.
Debentureholders are the Creditors of the Company.
2. Repayment

Normally, the amount of share is not returned during the life of the company.
Debentures are issued for a definite period.
3. Convertibility
Shares cannot be converted into debentures.
Debentures can be converted into shares.
4. Restrictions
There are legal restrictions to be fulfilled to issue shares at a discount.
There are no restrictions on the issue of debentures at a discount.
5. Purchase
A company can buy back its own shares, but subject to fulfillment of stipulated conditions.
A Company can purchase its own deben – tures from the market without any conditions.
6. Forfeiture
Shares can be forfeited for non-payment of allotment and call monies.
Debentures cannot be forfeited for non-payment of call monies.
7. Payment of dividend/ Interest
Shareholders will get dividend which is dependent on the profits of the company.
Debentureholders will get interest on debentures and will be paid in all circumstances, whether there is profit or loss.
Difference between Shareholders and Debentureholders
Basis of Difference
1. Status
Shareholders are the owners of the company.
Debentureholders are the creditors of the company.
2. Return

A shareholder gets dividend.
A Debenture holder gets interest on his investment at the rate stated whether or not there is a profit to the company.
3. Control
A shareholder has a right to control over the working of the company.
A Debenture holder has no such right to control.
4. Risk
Shareholders are at a greater risk. Even they can lose the amount invested in the shares.
Debenture holders are relatively safe. Secured debenture holders have almost no risk.