Professional Documents
Culture Documents
Introduction
Classification of Debentures. 8
Advantages and Disadvantages 11
Legal Compliances 16
Issue in private companies 24
Debentures and Debt Market: Indian Context 27
Conclusion.. 30
Introduction:
Finance is the lifeblood of every business. It is perhaps the most crucial factor in deciding fate of
any business enterprise. Finance is required in day-to-day transactions of business as well as for
carrying out capital (long term) investments of the business. Keeping this in view, it is the most
important function of a financial manager that is to arrange funds for the business from different
sources. This becomes necessary under the fact that pre determined goals of business could only
be achieved when a business does not suffer from lack of finance. It is evident in daily lives too
that a person cannot carry on his daily tasks without having financial support. Other than this,
just like daily lives, a business cannot run smoothly in absence of finance.
This therefore is the most crucial decision that a financial manager needs to take up- composition
of capital structure of an organization. Following diagram shows capital structure and its various
components:
Other
Short
Term
Securities
Capital Structure of a
business organization
Borrowed
Capital (Debt)
Equity Capital
Preference Capital: Preferred stock, also called preferred shares or preference shares, is
typically a 'higher ranking' stock than voting shares, and its terms are negotiated between the
corporation and the investor. Preferred stock usually carries no voting rights, but may carry
superior priority over common stock in the payment of dividends and upon liquidation. Preferred
stock may carry a dividend that is paid out prior to any dividends being paid to common stock
holders. Preferred stock may have a convertibility feature into common stock. Preferred
stockholders will be paid out in assets before common stockholders and after debt holders in
bankruptcy. Terms of the preferred stock are stated in a "Certificate of Designation".
Debt Capital: Debt capital is the capital that a business raises by taking out a loan. It is a loan
made to a company that is normally repaid at some future date. Debt capital differs from equity
or share capital because subscribers to debt capital do not become part owners of the business,
but are merely creditors, and the suppliers of debt capital usually receive a contractually fixed
annual percentage return on their loan, and this is known as the coupon rate.
Debt capital ranks higher than equity capital for the repayment of annual returns. This means that
legally, the interest on debt capital must be repaid in full before any dividends are paid to any
suppliers of equity.
Our analysis will be based on long-term sources of funds: most specifically debt finds. In India,
it is important to understand that, there is no bond market. Companies and government most
often come up with issue of a long-term debt instrument known as debenture. Let us move
forward and understand meaning of term debenture, especially in context of Indian financial
markets.
Following are the basic features of debentures that differentiate them from other sources of
finance. After understanding meaning of different capital structures, we need to understand
peculiar characteristics of debentures that make them different from commonly used finance
sources:
Investors who invest in the debentures of the company are not the owners of the
company. They are the creditors of the company or in other words, the company borrows
the money from them.
Funds raised by the company by way of debentures are required to be repaid during the
life time of the company at the time stipulated by the company. As such, debenture is not
a source of permanent capital. It can be considered as a long-term source.
In practical circumstances, debentures are generally secured i.e. the company offers some
of the assets as security to the investors in debentures.
Return paid by the company is in the form of interest. Rate of interest is predetermined,
but the company can freely decide the same. The interest on debenture is payable even if
the company does not earn the profits
In financial terms, debentures prove to be a cheap source of funds from the companys
point of view
So this thing needs to be kept in mind by a company that an investor is expected to invest in
debentures only when liquidity and financial position of company is very sound. An investor is
always careful before investing in any company, especially in debt instruments where there is
hardly any chance of capital appreciation. So, a company that is very much sure about it financial
well-being could very well come up with issue of debentures. Debentures are also ideal for
companies, which do not want any kind of dilution in control of management. That means,
organizations, which do not want to issue shares, could come up with issue of debentures.
Apart from that, financial manager must make sure that company is in sound enough position to
make periodic interest payments and also, repayment of principal amount at the right time.
Classification of debentures
In India, debentures could be classified in basically two categories: on the basis of security and
on the basis of convertibility. Following diagram shows details of classification of debentures in
Indian context:
Classification
Of Debentures
On the basis of
convertibility
Fully Convertible
On the basis of
Security
Secured
Debentures
Partly Convertible
Non-Convertible
Unsecured
Let us now discuss each of the types of debentures, which are issues in market by companies
to
Debentures
raise funds.
Optionally Convertible
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Fully convertible Debentures (FCD): These are fully convertible into Equity
shares at the issuer's notice. The issuer decides the ratio of conversion. Upon conversion
the investors enjoy the same status as ordinary shareholders of the company.
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, his assets can be sold to repay the liability to the investors.
Unsecured Debentures: These instruments are unsecured in the sense that if the
issuer defaults on payment of the interest or principal amount, the investor has to be
along with other unsecured creditors of the company.
Along the dimension of security, we have seen that debenntures have been classified into
unsecured(Straight) and secured (mortgage) debentures. Unsecured debentures do not carry any
cahrge on specific assets of the company while secured debentures carry a fixed or floating
charges on assets of company.
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The distinction between secured and unsecured debentures becomes relevant in case the issuer
defaults in payment of interest and principal amount so taken from investors. Secured debenture
holders are entitled to take possession of security given to them and realize their dues by selling
these assets, which are most commonly- land, buildings, plant, machinery of business. This right
is valuable to debenture holders provided security is valuable, easily saleable and has not been
simultaneously given as security to other creditors as well. All these factors have to be examined
while evaluating debenture. Unsecured debenture are not backed by any such security, but an
investor needs not worry about that if he has a belief that company is doing financially and
chances of default are very bleak.
Advantages of Debentures
Continuing the classification of debentures, next step to be undertaken during course of our
analysis is to look at fact as to how debentures have an advantage over other sources of long-
term finance. In this section of our study, we shall look as to what are the pros and cons of
debentures that make it one of the most reliable sources of long-term finance and also create a
huge scope in Indian financial markets.
Following are advantages of debentures that make them a reliable source of finance as compared
to other long-term finance sources:
Let us divide our analysis into three major points i.e., division of advantages of debentures by
different prospective:
Advantages of Debentures
General Advantages
Advantages to
Investors
Advantages to Financial
Institutions
Let us now take a look at the description of above-mentioned topics in brief. During course of
description, efforts will be made to make sure that a reader understands relative advantage of
debentures and conclusions could be drawn out as to how under utilized this very source of
finance has been in Indian context:
General Advantages:
These advantages are highly dependable on the success rate of the current interest rate and
economic situation of society.
Success or Failure: You are taking a great risk when investing in a corporate
debenture because the success of the company will determine how valuable your
debenture is. A company debenture is only valuable when the company is successful and
profitable, but if it fails, then you will lose a great amount of money. Debentures and
bonds hold greater risks because the company could eventually go out of business, so this
type of investment should be done very carefully.
Debentures can be a very attractive form of investment, but only should be taken advantage of
with companies that have a very high probability of being successful. Large and already
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successful businesses are smart forms of investments when considering buying corporate
debentures.
Advantages to investors:
They have the possibility to acquire shares at a lower price to that of the market- by way
of investment in convertible debentures with embedded options of conversion into equity
shares.
They have the right for subscription of shares at a lower price to that of the market.
The price of conversion is always lower to that of the market so the effects of a possible
inflation are mitigated. This inflation effects causes a rise on the stocks quotations.
There is an improvement in the financial structure of the company, because the extra
resources (debentures) are transformed into own resources (shares). It transforms debt
into capital.
The financial cost is lessening, because if the investor chooses for the conversion they
dont have to obey the requisites from the debentures: to pay interests and to refund the
capital. On the other side, the interests from the debentures or bonds are usually lower
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than that on the market, this way, in case of not converting, the company will finance
itself with cheap debt.
The sooner the conversion is made, the greater are the discounts, so the lesser are the
numbers of shares that you can obtain with each debenture.
After talking about advantages of debentures, lets take a look on various demerits this source of
finance suffers from. No doubt that there are few cons from which debentures suffer, but these
demerits are small enough to overlook and advantages always override the disadvantages:
General Disadvantages:
By issuing the debentures, the company accepts the risk of two types. These are payment
of the interest at a fixed rate, irrespective of the non-availability of profits and repayment
of principal amount at the pre-decided time. If earnings of the company are not stable or
if the demand for the products of the company is highly elastic, debentures prove to be a
very risky proposition for the company. Any adverse change in the earnings or demand
may prove to be fatal for the company.
Debentures are usually a secured source for raising the long-term requirement of funds
and usually the security offered to the investors is the fixed assets of the company. A
company, which requires less investment in fixed assets, such as a trading company, may
find debentures as a wrong source for raising the long-term requirement of funds, as it
does not have sufficient fixed assets to offer as security.
The securities have a less quotation price due that temporarily they have lesser rights.
They are less liquid, due that there is a lesser amount of them.
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You cant dispose of money soon due to the former explanation. Usually the type of
interests that they offer is inferior to that of the ordinary debentures due that they offer
the additional advantage of placing them as shares on the market.
You cant foresee an exact dividend distribution politic due that existing amounts of
shares swill depend on the number of debentures that will exercise their option of
conversion.
There are doubts when you cant calculate the interests of the debentures. Again, the
number of securities to be converted is unknown or unknown of the amount of funds to
be returned with the amortizations.
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implications involved here. Being a part of good corporate governance, a company secretary
shall make efforts to make sure that no point of law is not missed out by anyway possible. Other
than this, a company secretary shall be responsible for any discrepancies that might arise after
issuance of debentures. As a huge amount of public savings is involved in debentures,
government and SEBI have been stringent enough while formulating procedures and policies for
issuing guidelines. More than companys interests, interests of investors have been given much
more weight while formulating rules and regulations of debenture issue. We shall look at them in
brief and that will help us in understanding role of a company secretary in complying with
directives issued by concerned authorities.
Unlisted public company or a private company proposing to convert itself into public
company.
For issue of all types of debentures, credit ratings from a credit rating agency of not less than
investment grade shall be obtained from not less than two registered credit rating agencies and
disclosed in the offer documents.
In the case of public issue of debentures, there would be a large number of debenture holders on
the register of the company. As such it shall not be feasible to create charge in favour of each of
the debenture holder. A common methodology generally adopted is to create Trust Deed
conveying the property of the company. A Trust deed is an arrangement enabling the property to
be held by a person or persons for the benefit of some other person known as beneficiary. The
Trustees declare the Trust in favour of the debenture holders. The Trust Deed may grant the
Trustees fixed charge over the freehold and leasehold property while a floating charge may be
created over other assets. The Company shall allow inspection of the Trust Deed and also
provide copy of the same to any member or debenture holder of the company on payment of
such sum as may be prescribed. Failure to provide the same would invite penalties by way of fine
under the Act. Any provision contained in the Trust Deed, which exempts a Trustee from liability
for breach of Trust, is void.
As per Section 125 (4) of the Indian Companies Act, registration of a charge for purpose of issue
of debentures is mandatory. Section 128 stipulates that where a company issues series of
debentures which is secured by charge, benefit of which will be available to all debenture holders
pari passu, the company shall file the prescribed particulars in Form 10 and 13 with the Registrar
of Companies for registration of charge. These forms shall be filed within 30 days after the
execution of the deed.
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Insurance company.
Body Corporate.
II.
Ensuring that the assets of the company issuing debentures are sufficient to discharge
the principal amount.
III.
To ensure that the offer document does not contain any clause which is inconsistent
with the terms of the debentures or the Trust Deed.
IV.
To ensure that the company does not commit any breach of the provisions of the Trust
Deed.
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V.
VI.
VII.
If the debenture trustees are of the opinion that the assets of the company are
insufficient to discharge the principal amount, they shall file a petition before the
Central Government and the latter may after hearing the parties pass such orders as is
necessary in the interests of the debenture holders. As per the SEBI (Debenture
Trustees) Regulations, 1993, a Debenture Trustee can be a scheduled bank, an
insurance company, a body corporate or a public financial institution.
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The Debentures are issued either raised through private subscription or issue of a
prospectus to the public
A public financial institution or scheduled bank either underwrites the above issue or
subscribes to the issue of debentures, either wholly or in part or sanctions the whole or
part of the debenture; and
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The right of conversion may be at par or at a premium not exceeding 25% of the nominal
value of the shares.
Default
In the event of failure on the part of the company to redeem the debentures on the date of
maturity, the Company Law Tribunal may, on the application of any debenture holder, direct
redemption of debentures forthwith by payment of principal and interest due thereon. If a default
is made in complying with the orders of the Tribunal, every officer of the company who is in
default shall be punishable with imprisonment for a term, which may extend to three years and
shall also be liable to fine of not less than Rs.500/- for every day during which the default
continues. (Section 117C) Further this offence is not compoundable under section 621A of the
Act.
There are contradictions between the Companies Act and the SEBI regulations on issues relating
to:
a) Utilisation of Debenture Redemption Reserves. The Act provides that the Debenture
Redemption Reserve will be used towards redemption of debentures only whereas the SEBI
regulation states that these will be a part of the General Reserves, which can be utilised for the
purpose of bonus issues.
b) Any debentures issued with a maturity period of 18 months or less is exempted from the
creation of Debenture Redemption Reserve Account, whereas no such exemption is provided
under the Companies Act.
c) No Public Issue/Rights Issue of Debentures shall be made by a company unless it has
appointed one or more Debenture Trustees for such debentures whereas under SEBI guidelines,
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relatives. Hence, the Private Company must issue Debentures only as a Secured Debenture.
2) Approvals to be taken before proceeding for the issue: The following approvals are
required to be obtained by the Company:
Letter from Trustees Consent from the Debenture Trustees to act as Trustees.
No approvals are required to be obtained under Section 293(1)(a) and (d) since, the
Section does not apply to Private Limited Companies, unless it is a Subsidiary of a Public
Company.
3) Allotment: Since, the Company proposes to place the Debenture privately, it is suggested
that a Letter of Offer is also made which would be circulated amongst the target buyers. The
draft letter of offer is also required to be approved by the Board. The conditions relating to the
payment for subscription, the Security, the rate of interest on the Debentures and the period by
which the Debentures would be redeemed would have to be specified.
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6) Time Limit For Issue Of Debenture Certificate: The time limit for the issue of
Debenture Certificate is 3 months from the date of allotment. If the Company is of the opinion
that it might not be able to issue the Debenture Certificate within 3 months, then it is suggested
that an application is made to the CLB requesting for extending the time- limit for issue of
Debenture
Certificate.
10) Payment of stamp duty on the debentures: The stamp duty as prescribed under the
Stamp Act, as in force in state, required to be affixed to the Debenture Certificate on the face of
the same or in the form of attaching a separate sheet of paper and affixing the stamps on the
same. The fact that the stamps so affixed forms part of the Certificate with the Certificate
Number should be mentioned on the sheet so attached.
Alternative method:
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this analysis, we will be in a position to draw conclusions of illustration as well as make our
recommendations on project and debentures scenario in Indian market.
30%
Debt
Equity
70%
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5%
Debentures
Shareholders Funds
95%
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Conclusion
It is not just about a single company, whole debt market of India needs reorganization and that
too at a rapid rate. In todays context when due to recession, equity markets have fallen
drastically in India, debentures could just help in saving day for all troubled financial markets of
India. Apart from that, government should take account of SEBIs advices when the authority has
constantly urged them to work for organization of debt market in India. This is necessary because
in an emerging economy, it is important that there is an active participation of public in corporate
world activities. Role of a Company Secretary is important because in this condition hes the one
who has to maintain equilibrium between interest of investors, company and government of
India. This is perhaps real challenge that a Company Secretary will have to face in some years to
come.
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