Debentures and its impact on Company and Shareholders

This article titled ‘Debentures and its impact on Company and Shareholders’ is written by Mayank Shekhar and discusses the concept of debentures and its impact on the company and the shareholders of the company.

Debentures and its impact on Company and Shareholders

The term ‘debt’ comes from the Latin word ‘debere,’ which means ‘to borrow.’ A debenture is a written document that bears the company’s common seal and acknowledges a debt. It contains a contract for the repayment of principal after a specified period or at intervals at the company’s discretion, as well as a contract for the payment of interest at a fixed rate payable on fixed dates, usually half-yearly or yearly.

‘Debenture’ includes Debenture Inventory, Bonds, and any other securities of a company, whether or not they constitute a charge on the company’s assets, according to section 2(12) of The Companies Act, 1956.

‘Bond’ is another term used in the same context by businesses. A bond is a debt-acknowledgement instrument. Bonds were traditionally issued by the government, but now they are also issued by semi-government and non-governmental groups. The phrases ‘debentures’ and ‘bonds’ have become interchangeable in recent years.

I. Characteristics of Debenture

1. It takes the form of a firm’s certificate of indebtedness, which is issued by the corporation. It usually results in a charge on the company’s assets or undertaking. Usually, there is a deadline for redemption.
2. Unlike shareholders, debenture holders are creditors of the firm and have no claim to the company’s ownership.
3. Because the debenture holders are not the company’s owners, they have no right to the company’s administration and management.
4. Debenture holders do not have to worry about the company’s profits or losses since they have a predetermined rate of interest on the principal amount that they receive every year, regardless of the company’s financial status.
5. Debentures normally contain a charge on the business’s assets, which means that if the company falls into liquidation and is unable to repay the debt, the debenture holders may sell the company’s property via the legal procedure under relevant legislation to reclaim their money.
6. The corporation has made an assurance to repay debenture holders the principal amount plus interest at the specified period.
7. Debenture holders are not entitled to vote at any of the company’s meetings.
8. When a business is in the process of winding up, the company’s first priority is to repay the company’s debenture holders in accordance with relevant legislation, so there is no chance of the debenture holders losing money.

II. Advantages of using a debenture

1. Debentures are classified as creditors and hence have special treatment when it comes to repayment.
2. The board of directors is given assurance and financial security.
3. There is a method to build the firm over time at a set low cost.
4. Before dividends may be paid to shareholders, debenture holders must be refunded because the company’s ownership is not expanded, profit-sharing stays the same.
5. Debentures are a kind of debt financing that may be deducted from your taxes.
6. The company’s ownership is not diluted because the interest payments are predetermined regardless of the amount of profit, and a debenture has a disciplinary impact.

III. Disadvantages of using a debenture

1. Payments to the debenture holder have no flexibility.
2. The firm may not be able to sell certain assets if the debenture is secured.
3. Debenture holders are not permitted to vote or participate in profit distributions.
4. In low-inflationary eras, this is not a smart investment option.

IV. Its impact on the company and shareholders

Debentures, like other bonds, may make periodic interest payments known as coupon payments. Debentures, like other forms of bonds, are formalised in an indenture. Bond issuers and bondholders enter into a legally enforceable contract known as an indenture.

The contract outlines the maturity date, the scheduling of interest or coupon payments, the method of interest computation, and other aspects of a debt offering. Debentures may be issued by both corporations and governments.

Long-term bonds—those having maturities of more than ten years—are the most common kind of bond issued by governments. These government bonds are considered low-risk investments since they are backed by the government issuer. Debentures are long-term loans used by corporations.

Corporate debentures, on the other hand, are unsecured. Instead, they are solely backed by the underlying company’s financial sustainability and trustworthiness. These debt instruments have an interest rate attached to them and are redeemable or repayable on a certain date.

These planned debt interest payments are often made before a corporation pays stock dividends to shareholders. Companies benefit from debentures because they have lower interest rates and longer payback terms than other forms of loans and debt instruments.

Debentures are less hazardous than investing in the same company’s ordinary stock or preferred stock since they are debt instruments. In the event of bankruptcy, holders of debentures would be regarded as more senior and would take precedence over other forms of investments.

Conclusively, these loans, however, are fundamentally riskier than secured obligations since they are not backed by any collateral. As a result, interest rates on these bonds may be higher than on other identical collateral-backed bonds from the same issuer.

Dividend payments and partial liquidation rights are usually offered to preferred shareholders. Shares, on the other hand, continue to trade publicly on an exchange, with the market determining the value.

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References

1. Sarita Singh, Legal Concept and Provision of Debentures, Available Here.

2. James Chen, Debenture, Available Here.

3. Difference between Bonds and Debentures, Available Here.

4. Difference Between Shares and Debentures, Available Here.

5. Advantages and Disadvantages of Shares and Debentures, Available Here.

6. Mr Jose M Cartas and Mrs Qi He, Handbook on Securities Statistics, Available Here.

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