Adequate amount of capital is necessary to run a business effectively/successfully. In some cases capital arranged through internal resources i.e. by way of issuing equity share capital or using accumulated profit is not adequate and the organisation is resorted to external resources of arranging capital i.e. External Commercial borrowing (ECB), Debentures, Bank Loan, Public Fixed Deposits etc.
When a company needs funds for extension and development purpose without increasing its share capital, it can borrow from the general public by issuing certificates for a fixed period of time and at a fixed rate of interest. Such a loan certificate is called a debenture.
Debentures are offered to the public for subscription in the same way as for issue of equity shares. Debenture is issued under the common seal of the company acknowledging the receipt of money.
According to Section 2(30) of Companies Act 2013 “debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not; It is evident from the definition that the term debentures covers both secured and unsecured debentures.
The important features of debentures are as follows:
1. It is issued by the Company in the form of a certificate under the common seal.
2. Debenture holders are the creditors of the company
3. Debentures carry a fixed rate of interest.
4. Debenture is redeemed after a fixed period of time.
5. Debentures may be either secured or unsecured.
6. Interest payable on a debenture is a charge against profit and hence it is a tax deductible expenditure.
7. Debenture holders do not enjoy any voting right.
8. Interest on debenture is payable even if there is a loss.
Debentures are generally classified into different categories on the basis of:
1. Convertibility of the Instrument
2. Security of the Instrument
3. Redemption ability
4. Registration of Instrument
(i) Non Convertible Debentures (NCD): These instruments retain the debt character and cannot be converted into equity shares.
(ii) Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.
(iii) Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.
(iv) Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at a price decided by the issuer/agreed upon at the time of issue.
(A) 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, such fixed assets can be sold to repay the liability to the investors.
(B) Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be included as unsecured creditors of the company.
(A) Redeemable Debentures: It refers to the debentures which are issued with a condition that the debentures will be redeemed at a fixed date or upon demand, or after notice, or under a system of periodical drawings. Debentures are generally redeemable and on redemption these can be reissued or cancelled.
(B) Perpetual or Irredeemable Debentures: A Debenture, in which no specific time is specified by the companies to pay back the money, is called an irredeemable debenture. The debenture holder cannot demand repayment as long as the company is a going concern. Issuing company has to pay interest periodically. But all debentures, whether redeemable or irredeemable become payable on the company going into liquidation. However, after the commencement of the Companies Act, 2013, now a company cannot issue perpetual or irredeemable debentures.
(A) A Registered Debentures: Registered debentures are issued in the name of a particular person, whose name appears on the debenture certificate and who is registered by the company as holder on the Register of debenture holders.
(B) Bearer debentures: Bearer debentures on the other hand, are issued to bearer, and are negotiable instruments, and so transferable by mere delivery like share warrants.