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In corporate finances, debentures are seen as an alternative to shares or simple bank loans and are used to raise funds to finance desired projects and goals of a company. The two main reasons why a company may opt to go for raising funds through debentures instead of selling shares and taking loans from the bank is that, if they sell company shares, the company will have to dilute a certain portion of their equity, and also lose a certain portion of their decision-making rights and powers and on the other hand, if thy take loans from a bank, they will have to keep some of their assets in the bank as collateral until they can give all the money back.
Characteristics of Debentures
The main features of this type of debt instrument are as follows;
- A debenture is acknowledged by the company as a debt or a loan to the lender. It is presented in the form of an official written document.
- Important terms and conditions of the debenture are mentioned properly by the company in the debenture itself, and then it is authorized by the company seal.
- It must be noted that in the case of a debenture, the holder of the debenture will be the moneylender to the concerned company.
- As per the maturity period of a debenture is concerned, it usually ranges from ten to twenty years, and the lender or debenture holder is aware of the maturity period. At the time of maturity period, the company repays the amount of money that was taken from the holder plus the interests that were promised/offered in the debenture certificate at the time of issue.
- It must be noted that the debenture holders will have a priority. They will have the preference over preference shareholder and equity holders as far as claiming their assets are concerned if they do not get their principal capital in due time.
- Holders will get a fixed amount of money at the end of every financial year till all the invested amounts are cleared in due time.
- The holders will not have any say in the internal decisions of the company like a shareholder.
- A trustee is appointed to ensure that both concerned parties must be fulfilling their roles and are not failing their contractual obligations. In most cases, financial institutions take up this role.
Time Limit for Allotment of Debentures
As directed by Section 42(6), the time limit for allotment of debentures is 60 days. The starting date will be counted from the immediate date after the funds are received.
Top Five limitations of Debentures in India
- Reduces the company’s potential- The potential of a company will be reduced if they borrow money in the form of debentures as in most cases, the company has to mortgage their assets to the debenture holders. So, even if they are getting funds, they are losing control over their valuable assets on the other hand. This reduces the growth potential.
- No active involvement or feedback from the investors- We know that shareholders who have a certain portion of the company’s equity, have a say in terms of the company’s decision-making, management, financing strategies, etc. the same valuable feedback and active participation of the investors are not available in case of debentures. The investors are only interested in making profits. This is a major issue in India.
- The burden of interest- Debentures are usually mid to long-term contracts and the company has to pay a certain sum of money as interest after every financial year until they fully give the money back.
- Risk caused by the fluctuating economy- In a fluctuating economy like India, the company does not make the same profit every year, and as debentures are non-flexible meaning there will be no adjustments in the payable interests if they earn a lesser profit in a year compared to its previous year or so. This puts pressure on the company’s credit and can potentially damage the entire reputation of the company.
- Weak role of the lender- People may find debentures as unattractive ventures to invest in due to their nature. It is a very simple system of money lending and offers no rights, equity, or active participation to its lenders. So, not many people are interested.
Conclusion
Even if debentures can be crucial for a company, there are multiple limitations of debentures as well both for the lender and the company. The limitations of debentures in India are still existing and are continuously resulting in damaging a company’s reputation, capital gains, growth potential.
