DebenturesDebentures can be addressed as a vital tool for raising long term debt capital. A company can raise funds through issue of debentures, which bear a fixed rate of interest. The debenture issued by a company is referred to as an acknowledgment that the company has borrowed a particular amount of money that has to be repaid at a future date. Debenture holders are, hence, known as creditors of the company. Debenture holders are paid a fixed amount of interest at precise intervals may be, six months or one year. Public issue of debentures requires that the issue be rated by a credit rating agency like CRISIL (Credit Rating and Information Services of India Ltd.) on aspects like past performance and track record of the company, its profitability, debt servicing capacity, credit worthiness and the perceived risk of lending. A company is liable to issue different types of debentures (see Box C and D). The Zero Interest Debentures (ZID) have become very popular in the recent past and the issue of Zero Interest Debentures (ZID) does not carry any explicit rate of interest. The difference between the face value of the debenture and its purchase price is the return to the investor.
The advantages of raising funds through debentures are given as follows:
- It is preferred by investors who want fixed income at lesser risk;
- Debentures are fixed charge funds and do not partake the profits of the company;
- The issue of debentures is appropriate when the sales and earnings are relatively stable;
- Since debentures do not carry the right to vote, financing through debentures does not dilute control of equity shareholders on management;
- Financing through debentures is less costly as compared to cost of preference or equity capital as the interest payment on debentures is tax deductible.
Debentures have specific limitations. These are listed below:
- As fixed charge instruments, debentures put a permanent burden on the earnings of a company. There is a greater risk when earnings of the company show variation;
- With respect to redeemable debentures, the company has to make provisions for repayment on a specified date, even during if the company is facing financial crisis;
- Each company is bound by certain borrowing capacity. With the issue of debentures, the capacity of the company to further borrow reduces.