Raising Funds by Issue of Debentures

Raising funds by issue of Debentures- Merits and Limitations

Raising Funds by Issue of Debentures

Although there are number of methods by which a company can borrow funds, yet to meet long term needs, a company, usually, borrows by issue of debentures.

Debentures: A debenture has been defined as an acknowledgment of debt under a seal containing terms and conditions of its repayment. According to Sec. 2 (12) of the Act “Debentures includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.”

Accordingly, a debenture may be secured or unsecured.

Issue of Debentures: There is nothing special and all the rules, with the following exceptions, as applicable to issue of shares are equally applicable to the issue of debentures. The important exceptions worth noting are:

  1. restriction regarding the minimum subscription;
  2. restriction on issue of debentures at discount; and
  • Requirements as to return of allotment are not required to be complied with in case of issue of debentures.

Merits of Debentures from the point of view of the company

  1. It enables a company to take the benefit of trading on equity.
  2. It is a cheaper method of raising finance as the rate of interest payable is very low.
  3. Debenture-holders do not have any voting right. As such they cannot interfere in the management of the company.
  4. Funds can be raised easily even during depression period when investors do not like to invest in equity shares.
  5. Interest payable on debenture is regarded as a charge against profit. As such profit are reduced and consequently there is reduction in tax liability also.

Merits of debentures from the point of view of the debenture holders

  1. Debentures offer a fixed return as such there is little or no risk.
  2. Debentures are secured. Therefore, these are regarded as safe investment.
  3. Debentures are redeemable after a certain period.
  4. In case the company goes into liquidation, debentures are paid first of all.

Limitations of debentures from the point of view of the company

  1. Payment of interest is compulsory. As such it might create problems in case company’s profit are inadequate or the company is running into losses.
  2. A company may not be in a position to issue debentures for a period exceeding 18 months if it has no security to offer.

Limitation of debentures from the point of view of the debenture-holders

  1. The debenture holders receive a very low return.
  2. Debenture holders cannot share the prosperity of the company.
  3. Debenture holders do not have any voting right.

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