Debentures are a type of long-term debt instrument issued by companies to raise funds from the public. They are essentially a way for companies to borrow money from investors, and they offer a fixed rate of return to the investor over a specified period of time.
Features of debentures:
- Fixed Interest Rate: Debentures offer a fixed rate of interest to the investor. This means that the investor will receive a fixed amount of interest on their investment, regardless of the performance of the company.
- Long-Term Investment: Debentures are a long-term investment, with a maturity period of usually 5-20 years. This makes them suitable for investors who are looking for a stable, long-term investment option.
- Secured or Unsecured: Debentures can be either secured or unsecured. Secured debentures are backed by the assets of the company, while unsecured debentures are not. Secured debentures are generally considered to be less risky than unsecured debentures.
- Convertible or Non-Convertible: Debentures can be either convertible or non-convertible. Convertible debentures can be converted into equity shares of the company after a specified period of time, while non-convertible debentures cannot be converted into equity shares.
- Priority Claim: In the event of the company going bankrupt, debenture holders have a priority claim over the assets of the company, ahead of equity shareholders.
- Tradability: Debentures can be traded on the stock exchange, making them a liquid investment option for investors.
Kinds of Debentures
There are several types of debentures that a company can issue, based on the terms and conditions of the debenture agreement. Here are some common types of debentures:
- Secured Debentures: These are debentures that are backed by the assets of the company. In the event of default, the debenture holders have the right to claim the assets that have been pledged as collateral.
- Unsecured Debentures: These are debentures that are not backed by any specific assets of the company. They are considered to be riskier than secured debentures and therefore offer a higher rate of return.
- Convertible Debentures: These are debentures that can be converted into equity shares of the company after a specified period of time. Convertible debentures offer the investor the potential for higher returns if the company performs well.
- Non-Convertible Debentures: These are debentures that cannot be converted into equity shares. They offer a fixed rate of return to the investor over the specified period of time.
- Redeemable Debentures: These are debentures that have a fixed maturity date and are repaid to the investor on that date. The company must make regular interest payments to the investor until the debenture matures.
- Irredeemable Debentures: These are debentures that do not have a fixed maturity date and can be redeemed only when the company decides to do so. They offer a fixed rate of return to the investor until the company decides to redeem them.
- Zero Coupon Debentures: These are debentures that do not pay any interest to the investor. Instead, they are sold at a discount to their face value and redeemed at their face value on maturity.
Debentures issue and Redemption
Debentures are typically issued by companies to raise long-term capital from the public. The process of issuing debentures involves several steps, including the following:
- Appointing a Debenture Trustee: The Company must appoint a debenture trustee, who is responsible for protecting the interests of the debenture holders.
- Deciding on the Terms and Conditions: The Company must decide on the terms and conditions of the debenture issue, including the interest rate, maturity period, and other features of the debenture.
- Drafting the Prospectus: The Company must prepare a prospectus, which is a legal document that provides details about the debenture issue. The prospectus must be filed with the relevant regulatory authority, such as the Securities and Exchange Board of India (SEBI).
- Marketing the Debenture Issue: The company must market the debenture issue to potential investors, such as institutional investors, banks, and retail investors.
- Allotment of Debentures: Once the debentures are subscribed to, the company must allot the debentures to the investors. The allotment process is typically overseen by the debenture trustee.
- Payment of Interest and Redemption: The Company must make regular interest payments to the debenture holders, as per the terms and conditions of the debenture issue. The company must also redeem the debentures on the maturity date, as specified in the prospectus.
Redemption of debentures refers to the process of repaying the principal amount of the debentures to the debenture holders on the maturity date. The redemption of debentures is governed by the terms and conditions of the debenture agreement.
Features of debenture redemption:
- Maturity Date: Debentures have a fixed maturity date, which is the date on which the company must redeem the debentures. The maturity date is specified in the debenture agreement.
- Redemption at Par: The Company must redeem the debentures at par value, which is the face value of the debentures. This means that the company must repay the full principal amount of the debentures to the debenture holders.
- Redemption Reserve: In India, companies must set up a debenture redemption reserve (DRR) to ensure that they have sufficient funds to redeem the debentures on maturity. The DRR must be created out of the profits of the company, and must be equal to 25% of the value of the outstanding debentures.
- Redemption Premium: Companies may also choose to pay a redemption premium to the debenture holders, which is an additional amount over and above the par value of the debentures. The redemption premium is specified in the debenture agreement.
- Redemption in Installments: Companies may choose to redeem the debentures in installments, rather than redeeming all the debentures on a single date. This can help to reduce the cash outflow for the company.
- Redemption at a Premium: In some cases, companies may choose to redeem the debentures at a premium, which means that they will pay more than the par value of the debentures. This may be done to incentivize debenture holders to redeem their debentures earlier than the maturity date.