Creditorship Securities also known as debt finance which means the finance is mobilized from the creditors. Debenture and Bonds are the two major parts of the Creditorship Securities.
Debentures
A Debenture is a document issued by the company. It is a certificate issued by the company under its seal acknowledging a debt.
According to the Companies Act 1956, “debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge of the assets of the company or not.”
Types of Debentures
Debentures may be divided into the following major types:
Unsecured debentures
Unsecured debentures are not given any security on assets of the company. It is also called simple or naked debentures. This type of debentures are treaded as unsecured creditors at the time of winding up of the company.
Secured debentures
Secured debentures are given security on assets of the company. It is also called as mortgaged debentures because these debentures are given against any mortgage of the assets of the company.
Redeemable debentures
These debentures are to be redeemed on the expiry of a certain period. The interest is paid periodically and the initial investment is returned after the fixed maturity period.
Irredeemable debentures
These kind of debentures cannot be redeemable during the life time of the business concern.
Convertible debentures
Convertible debentures are the debentures whose holders have the option to get them converted wholly or partly into shares. These debentures are usually converted into equity shares. Conversion of the debentures may be: Non-convertible debentures Fully convertible debentures Partly convertible debentures
Other types
Debentures can also be classified into the following types. Some of the common types of the debentures are as follows:
- Collateral Debenture
- Guaranteed Debenture
- First Debenture
- Zero Coupon Bond
- Zero Interest Bond/Debenture
Features of Debentures
Maturity period
Debentures consist of long-term fixed maturity period. Normally, debentures consist of 10–20 years maturity period and are repayable with the principle investment at the end of the maturity period.
Residual claims in income
Debenture holders are eligible to get fixed rate of interest at every end of the accounting period. Debenture holders have priority of claim in income of the company over equity and preference shareholders.
Residual claims on asset
Debenture holders have priority of claims on Assets of the company over equity and preference shareholders. The Debenture holders may have either specific change on the Assets or floating change of the assets of the company. Specific change of Debenture holders are treated as secured creditors and floating change of Debenture holders are treated as unsecured creditors.
No voting rights
Debenture holders are considered as creditors of the company. Hence they have no voting rights. Debenture holders cannot have the control over the performance of the business concern.
Fixed rate of interest
Debentures yield fixed rate of interest till the maturity period. Hence the business will not affect the yield of the debenture.
Advantages of Debenture
Debenture is one of the major parts of the long-term sources of finance which of consists the following important advantages:
Long-term sources
Debenture is one of the long-term sources of finance to the company. Normally the maturity period is longer than the other sources of finance.
Fixed rate of interest
Fixed rate of interest is payable to debenture holders, hence it is most suitable of the companies earn higher profit. Generally, the rate of interest is lower than the other sources of long-term finance.
Trade on equity
A company can trade on equity by mixing debentures in its capital structure and thereby increase its earning per share. When the company apply the trade on equity concept, cost of capital will reduce and value of the company will increase.
Income tax deduction
Interest payable to debentures can be deducted from the total profit of the company. So it helps to reduce the tax burden of the company.
Protection
Various provisions of the debenture trust deed and the guidelines issued by the SEB1 protect the interest of debenture holders.
Disadvantages of Debenture
Debenture finance consists of the following major disadvantages:
Fixed rate of interest
Debenture consists of fixed rate of interest payable to securities. Even though the company is unable to earn profit, they have to pay the fixed rate of interest to debenture holders, hence, it is not suitable to those company earnings which fluctuate considerably.
No voting rights
Debenture holders do not have any voting rights. Hence, they cannot have the control over the management of the company.
Creditors of the company
Debenture holders are merely creditors and not the owners of the company. They do not have any claim in the surplus profits of the company.
High risk
Every additional issue of debentures becomes more risky and costly on account of higher expectation of debenture holders. This enhanced financial risk increases the cost of equity capital and the cost of raising finance through debentures which is also high because of high stamp duty.
Restrictions of further issues
The company cannot raise further finance through debentures as the debentures are under the part of security of the assets already mortgaged to debenture holders.
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