A debenture is a legal document that represents a secure means by which a creditor can lend money to the debtor.
Debentures are a form of long-term debt instrument issued by a company to raise funds from the public. It is a popular financing tool used by companies for various purposes, including capital expenditure, expansion plans, and debt refinancing. Debentures are a crucial aspect of the corporate world, and their issuance is governed by the Companies Act, 2013.
Meaning of Debentures
According to Section 2 (30) of the Companies Act, 2013, “Debenture” includes debenture stock, bonds or any other instrument of a company that is evidence of a debt, whether it has or not constituted a charge on the assets. Debenture can be classified as:
- Secured Debenture
- Unsecured Debenture
Debentures are a type of debt instrument that companies use to raise capital. When a company issues debentures, it borrows money from investors and promises to repay the amount with interest at a predetermined date in the future. Debentures are usually issued by large companies that have a good credit rating and can easily raise money from the public. Debenture holders have no ownership in the company, but they do have the right to receive interest and principal payments according to the terms of the debenture agreement.
Conditions for Issue of Debenture
- No company will issue any debentures that carry any voting rights.
- No company will issue a prospectus or make an offer or invitation to the public or to its members in excess of five hundred for the subscription of its debentures, unless the company has, previous to such issue or offer, selected one or more debenture trustees and the prescribed conditions that govern the appointment of such trustees.
- An issue of debenture for more than 500 members or any number of public that is subject to clarification from government without the creation of a debenture trust is forbidden.
- A debenture trustee will take steps to protect the interests of the debenture holders and remedy their grievances.
- Any provision of trust deed or contract that is protected by trust deed, exempting a trustee or indemnifying him against any liability for violation of trust will be void.
- If any default is made in compliance with the order of the Tribunal under this section, every officer of the company who is in default will be punishable with imprisonment for a term which may extend to a period of 3 years or with fine which will not be less than Rs 2 lakh but which may extend to Rs five lakh or with both.
Types of Debentures
- Convertible Debentures – These are debentures that can be converted into equity shares at a predetermined price and time.
- Non-Convertible Debentures – These are debentures that cannot be converted into equity shares and are only redeemed for a fixed amount of money.
- Fully Convertible Debentures – These are debentures that are converted into equity shares at a predetermined ratio and at a predetermined time.
- Partly Convertible Debentures – These are debentures that can be converted into equity shares only in part, and the remaining portion is redeemed for a fixed amount of money.
Benefits of Issuing Debentures
- Lower Interest Rates – Companies can usually raise capital at a lower interest rate by issuing debentures compared to other sources of debt financing.
- Diversification of Funding Sources – Issuing debentures allows companies to diversify their funding sources and reduce their reliance on bank loans or equity financing.
- Longer Repayment Period – Debentures have a longer repayment period compared to other forms of debt financing, which gives companies more time to generate cash flows to repay the debt.
- No Dilution of Ownership – Debentures do not dilute the ownership of existing shareholders, unlike equity financing.
Drawbacks of Issuing Debentures
- Interest Payments – Companies are required to make regular interest payments to debenture holders, which can put a strain on their cash flows.
- Strict Covenants – Debenture agreements often come with strict covenants that companies must adhere to, which can limit their financial flexibility.
- Default Risk – If a company is unable to make interest or principal payments on its debentures, it may default on its debt obligations, which can negatively impact its credit rating and reputation.
- Market Risk – The value of debentures can fluctuate based on market conditions, which can result in losses for investors.
Procedure for Issuing Debentures
- Board Resolution: The first step is to pass a board resolution approving the issuance of debentures and specifying the terms and conditions of the issue.
- Debenture Trust Deed: The company needs to create a debenture trust deed, which is a legal document that specifies the terms and conditions of the debenture issue and the obligations of the company and the debenture trustee.
- Credit Rating: The company needs to obtain a credit rating from a recognized credit rating agency to determine the creditworthiness of the debenture issue.
- Prospectus: The company needs to prepare a prospectus containing all the details of the debenture issue, including the terms and conditions, the use of proceeds, the credit rating, and the risk factors.
- SEBI Approval: If the debenture issue is for an amount exceeding INR 500 crores, the company needs to obtain approval from the Securities and Exchange Board of India (SEBI).
- Allotment of Debentures: After the debenture issue is oversubscribed, the company needs to allot the debentures to the applicants and receive the subscription amount.
How does a Company Issue Debenture to the Public?
- Determine the need for Debentures: The first step in issuing debentures is for the company to determine the need for such an instrument. Companies typically issue debentures to raise long-term capital for a variety of purposes, including expansion, working capital, or debt refinancing. The company must analyze the market conditions, interest rates, and other factors to determine the best time to issue the debentures.
- Formulate a Debenture Issue Plan: Once the need for debentures has been established, the company must formulate a debenture issue plan. This plan includes the type of debentures to be issued, the amount to be raised, the duration of the debentures, the interest rate to be offered, and the terms and conditions of the issue.
- Appoint a Debenture Trustee: A debenture trustee is an independent entity that is appointed by the company to oversee the interests of the debenture holders. The trustee is responsible for ensuring that the company adheres to the terms and conditions of the debenture issue and that the interests of the debenture holders are protected.
- File a Prospectus: Before issuing debentures to the public, the company must file a prospectus with the regulatory authorities. The prospectus contains detailed information about the company, the debenture issue, and the terms and conditions of the issue. The prospectus must be approved by the regulatory authorities before the company can proceed with the issue.
- Issue the Debentures: Once the prospectus has been approved, the company can proceed with the debenture issue. The company typically offers the debentures to the public through a public offer or private placement. In a public offer, the debentures are offered to the general public through a prospectus, while in a private placement, the debentures are offered to a select group of investors.
- Listing and Trading: After the debentures have been issued, the company must apply for listing on the stock exchange. Once listed, the debentures can be traded on the stock exchange like any other security.
FAQs
What is a debenture?
A debenture is a long-term debt instrument issued by a company to raise capital. It is a form of a loan that investors provide to the company in exchange for periodic interest payments and the return of the principal amount at maturity.
Why do companies issue debentures?
Companies issue debentures to raise long-term capital for various purposes such as expansion, modernization, and meeting working capital requirements. Debentures are a cost-effective way for companies to secure funds compared to equity financing.
What is the process of issuing debentures?
The process involves the company deciding the type and terms of debentures, obtaining necessary approvals, preparing a prospectus or offer document, and then making the offer to the public or a specific group of investors. The company receives funds from investors upon the issuance of debentures.
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