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If one asks how to define redemption by conversion, here is the answer:
Redemption of debentures means the enterprise recompensates the number of debentures to the holders. In simple words, we can say that redemption of debenture means repaying the due amount of debentures and discharging the liability on account of debentures. The new shares or debentures have significant differences, such as the shareholders are partly the owners of the company. In contrast, the debenture holders are the company’s creditors. The prospectus for redemption and the issue of debentures specify the preconditions. Debentures are a charge on assets. An asset is the economically vital resource of any entity, that in future shall be helpful in the production of any positive economic value. Hence, their repayment is necessary per the terms of the issue clearly stated in the debenture certificate.
SEBI (Securities and Exchange Board of India) Guidelines for Redemption of Debentures
According to SEBI, there are two basic postulates or guidelines for the redemption of debentures. These postulates are as follows:
- The obligation to create Debenture Redemption Reserve is only for the non-convertible debentures. It is also applicable to the non-convertible part of partly convertible debentures).
- The unlisted company must create a Debenture Redemption Reserve, at least 10% equivalent to the nominal value of those outstanding debentures.
List of the Sources of Finance for the Redemption of Debentures
The company can manage to pay the required amount for the redemption of debenture by conversion from the following sources:
- Redemption of debentures out of capital
- Redemption of debentures out of profit
- Redemption of debentures out of capital and profits
Redemption of Debenture Out of Capital
When no profits are left to redeem debentures, it is known as the redemption of debenture out of capital. Thus, no profits are to be transferred to Debenture Redemption Reserve in such conditions. According to the SEBI ( Securities Board of Exchange ) guidelines in Section 71 (4) of the Companies Act 2013, the listed companies are not required to create Debenture Redemption Reserve.
It also indicates that unlisted companies must maintain Debenture Redemption Reserve equal to 10% of the face value of outstanding debentures out of divisible profits. The remaining 90% of their debenture will be useful to redeem out of capital.
Redemption of Debenture Out of Profits
Redemption of debenture out of profit occurs when an appropriate amount of profits transfers from the Profit and Loss Appropriation Account to the Debenture Redemption Reserve Account. This transfer happens at the time of redemption of debentures. This transfer of profit to debenture eventually reduces the total amount of profit for the dividend. Thus, it is called redemption out of profit. To conclude, we can say that this redemption out of debenture does not affect the company’s existing resources.
Redemption of Debentures Out of Capital and Profits
As the name suggests, the redemption of debentures is out of capital and profits. This kind of redemption shall have some percentage of debentures out of capital and the rest out of profits.
Difference between Shares and Debentures
Basis of Difference | Shares | Debentures |
Ownership | The shareholders of the company hold ownership of that company. | The company’s debenture holders are not the owners but the creditors of the company. |
Form of Return | Shareholders of the company receive returns in the form of dividends. | The debentures of the company receive returns in the form of interest. |
Convertibility | It is impossible to convert a share into debenture. | It is possible to convert a debenture into a share. |
Control in Company | Shareholders have the right to attend and vote in important company meetings. | Debenture holders do not have the right to attend and vote in important company meetings. |
Certainty of Return | No certainty of return if the company is under loss. | The certainty of return is fixed even if the company bears a loss. |
Conclusion
Debentures are a type of investment or marketable security issued by an entity to raise money for long-term activities. The redemption of debenture by conversion means repaying the due amount of debentures and discharging the liability on account of debentures. SEBI specifies two basic postulates or guidelines for the redemption of debentures. The company can pay the required amount to redeem debentures from three sources, i.e., the redemption of debentures out of capital, out of profit and out of both. The new shares and debentures have a significant difference as the shareholders of the company hold ownership of that company. In contrast, the debenture holders are not the owners but the creditors of the company.
