Introduction Issue of Debentures
A debenture is a form of borrowing that the company takes from the public when it is in the need of finance for its business. It is a form of a loan with a fixed interest-bearing cost. Debentures are the written instruments that are issued by the company under their common seal against loan received. They are just like a loan certificate. Debentures are issued for a fixed period with the fixed rate of interest that is payable monthly, half-yearly or annually. Like public issues, debentures are also issued to the public at large. A debenture is one of the important sources of finance for large companies. Debentures are defined under Section 2(30) of Companies Act 2013
Statutory provisions for regulating Issue of Debentures
Applicable laws for governing issue of debentures are:
- Section 71 of the Companies Act 2013:
A company can issue the debentures with an option of conversion into equity shares at the time of redemption but they cannot issue debentures with voting rights.
- Rule 18 of Companies (Share Capital & Debenture) Rules, 2014:
A company can issue secured debenture by following the provisions & guidelines of these rules.
Types of Debentures
There are following types of debentures that a company can issue are:
- Secured debentures
These are the debentures that are issued by securing them against the asset of the company. The charge is created on the assets of the company in case of default in repayment of Companies. The assets will be sold to pay such loan amounts in case the company does not have sufficient funds to repay the debentures. The charge can be:
- Fixed: the charge against specified assets
- Floating: the charge against all the assets of the company
Such forms of debentures are those that don't create the charge on any assets. These types of debentures are least issued in companies of India.
Debentures are payable at the end of the predetermined term. That is they are payable at the maturity of the specified period in lump sum amount or installments. Redeemable debentures are redeemed at par, premium or discount.
These debentures are perpetual. These are not payable on the expiry of some fixed time rather they are redeemable after a long cified interval or when the company goes on liquidation.
Such debentures have no option of conversion into shares of any kind. These debentures remain debentures till the maturity. These are the most common form of debentures.
Here the debenture holder gets an option of partial conversion of his debentures. With this after conversion, he will be both, the creditor & shareholder of a company.
These debentures are fully convertible into shares. Thus if the debenture holder opts after a specified time all his shares will be converted to equity shares.
Features of debentures
Following are the unique features of debentures that make them a suitable form of borrowing:
- Debentures are the debt instruments; the holder of instruments known as debenture holders becomes the creditor of the Company.
- These are the certificate of debt which contains the details of the date of redemption & amount of repayment along with interest. The certificate is issued under the Company Seal.
- Debentures are issued on a fixed rate of interest which is paid half-yearly or annually.
- Debenture holders are the creditors of the Company & not the owners thus they don’t get any voting rights.
- The interest paid is charged against the profit of the Company & thus they are payable in case of losses.
Advantages of debentures
- The company gets the fund without diluting equity
- Interest paid on debentures is charged against profit thus they are a tax-deductible expense.
- Debenture issue is a cheaper form of loan as compared to other borrowings.
- Debentures encourage long-term planning & funding for long term
- Debentures are the least risky form of loan as they are secured & interest is paid in the case of losses also.
Distadvanatge of debentures
- Interest payable on debenture is a financial burden as it is a fixed cost & paid even during losses.
- Redemption is a cash outflow for the company that leads to imbalance the liquidity.
- During the depression, profits are reducing & fixed cost debentures can be very expensive due to their fixed interest rates.
Issue of Debentures
The issue of debenture is more or less similar to the equity issue. The company starts by releasing a prospectus & declares about the debenture issue. Interested investors then apply for the same. It’s upon the company either they demand full amount or partly by installments.
Terms of Issue of Debentures
Once the company invites for application & receives the application from investors those apply for debentures. The company can issue debentures in the following ways:
- Issue of debenture for cash:
Debentures are issued for cash in most common practice. It can be issued in three ways:
Debentures are issued at their nominal value. They are issued neither above nor below their face value. Now it depends upon the company that decides to take the full amount of investment in lump sum amount or installments. When debentures are issued at par, long-term borrowings mentioned on liabilities of Balance Sheet are equal to the asset side under the head cash, thus there is no need for further adjustments.
When the debentures are issued at a price higher than the nominal value it is termed as an issue of debentures on premium. Premium amount is credited to the Securities Premium Account and is reflected on the side of "Reserve & Surplus" of Balance Sheet.
When the debentures are issued at a value less than its nominal value, debentures are said to be issued at discount. The discount amount is treated as a capital loss and is charged to "Securities Premium Account". The discount can be later written off.
Issue of debentures for consideration other than cash:
Debentures are given for consideration other than cash. When the company has purchased certain assets or acquired certain business from vendors and instead of paying them cash, the company issue debentures to such vendors. In this case, also, debentures can be issued at par, premium & discount.
Issue of debentures as a collateral security:
Debentures are issued as collateral security against a bank loan or any borrowings from a bank or financial institution. Collateral securities are the second or parallel securities which are provided along with actual or primary security against the loan taken from the bank. These debentures are Contingent liabilities for a company. This means these liabilities may or may not occur. In the default in repayment of a loan by a company, this liability occurs.
Procedure for the issue of debentures
Step by step process for the issue of debentures to be followed by the company is:
- Convene & hold the board meeting. Decide the type of debenture to be issued & all the terms & conditions for the issue
- In the board meeting discuss the following agendas & pass a necessary resolution:
- Approve the offer letter & debenture subscription agreement
- Approve the PAS-5 for private placement
- Take the written consent of debenture trustees
- Resolve & appoint the debenture trustee
- Authorize the board to create a charge on assets for secured debentures
- Fix the day date & time for EGM & approve the notice of an EGM
- Issue the notice of EGM along with an explanatory statement
- Hold & convene the extra-ordinary general meeting & pass the necessary Special Resolution for increasing the borrowing power of the board.
- Within 30 days of passing Special Resolution in an extraordinary general meeting company has to file MGT-14 with ROC.
- Dispatch the letter of offer
- Open the separate schedule bank account
- File the letter of offer with ROC
- File GNL-2 with ROC along with the attachments of PAS-4 & PAS-5
- Receive the money for allotment of debentures from the investors
- After the closure of the offer convene another board meeting & discuss the following items:
- the board shall make the allotment of debentures within 60 days of the date of receipt of funds
- approve the agreement for charge creation
- approval of debenture trust deed
- File CHG-9 for the creation of charge within 30 days of the creation of charge.
- File return of allotment with ROC in form PAS-3 within 30 days of allotment.
Frequently Asked Questions (FAQs)
Company has to consider the following things while issuing debentures:
- Debentures can’t be issued with voting rights
- Debenture trustee has to be appointed by the company in case it issue debenture to more than 500 people.
- The company has to create a Debenture Redemption Reserve Account.
- Debenture Trustee can reach tribunal in case of any defaults in payments.
- The company can issue secured debentures with the date of the Redemption being less than 10 years from the date of issue.
- Secured debenture shall be issued by creating a charge.
- The company shall appoint a debenture trustee & shall execute debenture trust deed before the issue of prospectus.
- The charge shall be created in the favor of debenture trustee.
- Debenture trust deed has to be in format SH-12
Following are the different methods of redemption of debenture:
- Lump-Sum method
- Conversion method
- Installment method
- Purchasing method
When the applications received are more than the original number of shares offered for debenture issue. In this case of oversubscription, debentures are not allotted to certain applicant & the money is refunded to an applicant for non-allotment of debenture. Although money is not refunded to the applicant to whom debentures are issued and the money is adjusted against subsequent calls to be made.