A debenture is a debt instrument which is not backed by any security or collateral. The security of the debenture is the credit of the Company issuing the security. Higher the standing of the Company, lower is the interest rate offered on the debenture. Companies use debentures to raise funds in the medium or long-term.
Companies issue debentures as a method of raising loan capital. It is a certificate that says the Company is liable to pay interest. The money raised through debentures does not become part of the capital structure. Capital structure is debt or equity of the Company. Money raised through debentures is not share capital of the Company.
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1. Maturity of a debenture:
A Company gets funds for the long-term through debentures. Debentures have to be repaid within a particular time. The Company has to repay the amount borrowed within a particular date. If it fails to do so, creditors start winding up procedures to close down the Company. A Company can issue perpetual debentures which have no fixed time limit to pay back the principal amount. Creditors cannot force payments on perpetual debentures.
2. Interest on debentures:
Debentures have fixed rate of interest. A Company has a legal obligation to pay interest on debentures, irrespective of the amount it earns. If a Company is suffering heavy losses, it still has to pay interest to debenture holders. Bond holders get priority over preference and equity shareholders when it comes to claims over the Company.
3. Claims over assets of the Company:
Debenture holders enjoy priority over the preference and equity shareholders, when it comes to residual claims over the assets of the Company. This is a claim over Principal and Interest payments and not over the surplus assets of the Company. The secured debentures enjoy a priority over unsecured creditors of the Company vis-à-vis Company assets.
4. Debenture holders don’t have voting rights:
Debenture holders are the creditors of the Company. They don’t enjoy voting rights and debenture holders cannot dismiss the management of the Company.
5. Debentures have a call feature:
Debentures have a call feature which allows the Company to redeem debentures, before the maturity date. Debentures with the call feature provide a huge advantage to the Company vis-à-vis debenture holders. This is why call price is greater than issue price.
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