Debentures

Meaning: Debentures are an important instrument for raising long-term debt capital. A company raises funds by issuing debentures, which carry a fixed rate of interest. A debenture is an acknowledgement that the company has borrowed a certain sum, which it promises to repay at a future date. Hence debenture holders are the creditors of the company (not owners). They are paid a fixed, stated amount of interest at specified intervals (say, every six months or one year).

Credit rating: A public issue of debentures must be rated by a credit rating agency such as CRISIL (Credit Rating and Information Services of India Ltd.), which assesses the company's track record, profitability, debt-servicing capacity, creditworthiness and the perceived risk of lending.

Zero Interest Debentures (ZID): In recent years Zero Interest Debentures, which carry no explicit interest rate, have become popular. The investor's return is the difference between the face value and the (lower) purchase price.

Merits

• Preferred by investors who want fixed income at lower risk.
• Debentures are fixed-charge funds and do not participate in the company's profits.
• Suitable when a company's sales and earnings are relatively stable.
• Carry no voting rights, so financing through them does not dilute equity shareholders' control.
• Less costly than preference or equity capital because the interest is tax-deductible.

Limitations

• As fixed-charge instruments, they put a permanent burden on earnings — riskier when earnings fluctuate.
• For redeemable debentures, the company must arrange repayment on the due date even in financial difficulty.
• Each issue reduces the company's capacity to borrow further.

Types of Preference Shares (Box B): (This box, which appears alongside debentures in the text, lists the varieties of the preference shares introduced in §8.4.7.)

• Cumulative and Non-Cumulative: Cumulative preference shares can accumulate unpaid dividends and carry them to future years if not paid in a given year; on non-cumulative shares, an unpaid dividend is not carried forward. …