Financial Instruments and Business Structures: Debentures, Shares, and Company Types

Posted on Nov 5, 2025 in Business Administration and Management (BAM)

Types of Debentures

Debentures are long-term financial instruments issued by companies to raise funds from investors. They are a form of debt and come with a fixed interest rate. Debentures can be classified into different types based on convertibility, security, tenure, and transferability.

Based on Convertibility

  1. Convertible Debentures: These can be converted into equity shares after a specified period. They are further classified as:
    • Fully Convertible Debentures (FCDs): The entire debenture amount is converted into shares.
    • Partially Convertible Debentures (PCDs): A part of the debenture is converted into shares, while the rest is repaid in cash.
  2. Non-Convertible Debentures (NCDs): These cannot be converted into shares and are repaid in cash at maturity. They usually offer a higher interest rate to compensate for the lack of conversion benefits.

Based on Security

  1. Secured Debentures: These are backed by company assets as collateral. If the company fails to repay, the asset is sold to recover the amount.
  2. Unsecured Debentures: These are not backed by any asset and are issued solely based on the company’s creditworthiness. They carry a higher risk.

Based on Tenure

  1. Redeemable Debentures: These have a fixed maturity date when the principal amount is repaid to the investors.
  2. Irredeemable (Perpetual) Debentures: These have no fixed repayment date and continue indefinitely, with interest payments made regularly.

Based on Registration and Transferability

  1. Registered Debentures: Issued in the name of specific holders and cannot be transferred without formal procedures.
  2. Bearer Debentures: These are freely transferable by delivery and do not require registration in the company’s records.

Conclusion on Debentures

Debentures are a vital source of funding for companies, offering investors a fixed return with varying levels of risk and flexibility. Choosing the right type of debenture depends on the investor’s preference for security, convertibility, and liquidity.

Preference Shares

Preference shares are a type of equity share that gives shareholders priority over ordinary (equity) shareholders in receiving dividends and repayment of capital in case of liquidation. However, preference shareholders usually do not have voting rights in company decisions.

Types of Preference Shares

  1. Based on Dividend Payment

    • Cumulative Preference Shares: Unpaid dividends accumulate and are paid in future years.
    • Non-Cumulative Preference Shares: Dividends do not accumulate if not paid in a particular year.

  2. Based on Participation in Profits

    • Participating Preference Shares: Shareholders receive additional profits after paying equity shareholders.
    • Non-Participating Preference Shares: Shareholders get only a fixed dividend without additional profit-sharing.

  3. Based on Convertibility

    • Convertible Preference Shares: Can be converted into equity shares after a specified period.
    • Non-Convertible Preference Shares: Cannot be converted into equity shares.

  4. Based on Redemption

    • Redeemable Preference Shares: Can be repurchased by the company after a fixed period.
    • Irredeemable Preference Shares: Cannot be repurchased and exist indefinitely.

Key Features of Preference Shares

  • Fixed Dividend: Paid before any dividend is given to equity shareholders.
  • Priority in Liquidation: Preference shareholders are repaid before equity shareholders if the company shuts down.
  • Limited Voting Rights: Usually, they do not have voting rights except in specific circumstances.
  • Less Risky than Equity Shares: Provides stable returns to investors.

Conclusion on Preference Shares

Preference shares are ideal for investors looking for stable income with lower risk compared to equity shares. They help companies raise capital while ensuring priority payments to certain shareholders.

Redemption of Debentures

Redemption of debentures refers to the repayment of the principal amount by the company to debenture holders upon maturity or as per the agreed terms. It is the process through which a company settles its debt obligations.

Methods of Debenture Redemption

  1. Lump-Sum Payment at Maturity

    • The company repays the entire amount of debentures on a specific date.
    • Funds for repayment are often set aside in advance.

  2. Redemption by Installments (Sinking Fund Method)

    • A company redeems a portion of debentures at regular intervals.
    • A sinking fund is created to accumulate funds for redemption.

  3. Redemption through Purchase in the Open Market

    • The company buys back its debentures from the market when prices are low.
    • Helps reduce debt liability at a lower cost.

  4. Conversion into Shares or New Debentures

    • Some debentures are converted into equity shares or new debentures instead of cash repayment.
    • Beneficial for both the company and investors.

  5. Redemption from Capital

    • The company pays the debenture holders from its existing profits or capital reserves.

  6. Redemption from Profits (Debenture Redemption Reserve – DRR)

    • A company sets aside a portion of its profits into a Debenture Redemption Reserve (DRR).
    • Ensures funds are available for repayment at maturity.

Accounting Treatment for Redemption

  • Creation of Debenture Redemption Reserve (DRR) (as per regulatory requirements).
  • Transfer of profits to DRR before redemption.
  • Payment made to debenture holders or conversion recorded.

Conclusion on Redemption

The redemption of debentures is crucial for maintaining the company’s financial stability and creditworthiness. Proper planning ensures smooth repayment and avoids financial strain on the business.

Sources of Finance

A business requires funds for various activities such as operations, expansion, and investments. The sources of finance can be classified into internal and external sources.

  1. Internal Sources of Finance

    These funds come from within the business and do not require borrowing.

    • Retained Earnings: Profits reinvested in the business instead of being distributed as dividends.
    • Depreciation Reserves: Funds set aside for replacing assets.
    • Sale of Assets: Selling unused or old assets to generate funds.
    • Owner’s Capital: Investment made by the owners or partners.

  2. External Sources of Finance

    These funds are obtained from outside the business.

    A. Equity Financing (Ownership-based funds)

    1. Shares (Equity & Preference Shares): Raising money by issuing shares to investors.
    2. Venture Capital: Investment from venture capitalists in startups or high-growth companies.
    3. Angel Investors: Wealthy individuals who provide capital in exchange for ownership or equity.

    B. Debt Financing (Borrowed funds)

    1. Bank Loans: Borrowing money from banks for a fixed period with interest.
    2. Debentures: Long-term borrowing instruments with fixed interest payments.
    3. Bonds: Debt securities issued by companies or governments.

    C. Other Sources

    1. Trade Credit: Suppliers allow businesses to buy goods/services on credit.
    2. Leasing: Using an asset by paying rent instead of purchasing it.
    3. Government Grants & Subsidies: Financial aid from the government for specific projects.
    4. Crowdfunding: Raising small amounts of money from a large number of people, usually online.

    Conclusion on Sources of Finance

    Businesses use a combination of internal and external sources based on their needs, risk appetite, and financial condition. The right choice of finance ensures smooth business operations and growth.

    Private vs. Public Limited Company

    Companies are classified based on ownership, capital-raising ability, and regulatory compliance. The two primary types are Private Limited Companies (Pvt Ltd) and Public Limited Companies (Ltd).

    1. Private Limited Company (Pvt Ltd)

    A Private Limited Company is a type of business entity owned privately by a small group of individuals, such as family members, friends, or private investors.

    Key Features of a Pvt Ltd Company

    1. Limited Ownership: Shares are held by a specific group of investors and are not available to the public.
    2. Minimum & Maximum Members: Requires at least 2 and a maximum of 200 shareholders.
    3. Restricted Share Transfer: Shareholders cannot freely sell or transfer shares without the consent of other shareholders.
    4. Limited Liability: Shareholders’ risk is limited to the amount they invest in the company.
    5. No Stock Exchange Listing: Shares cannot be traded on stock exchanges.
    6. Fewer Compliance Requirements: Less legal and regulatory burden compared to public companies.

    Advantages of Pvt Ltd Companies

    • More Control: Owners have full decision-making authority.
    • Lower Compliance Cost: Less regulatory burden compared to public companies.
    • Stable Ownership: Prevents hostile takeovers.

    Disadvantages of Pvt Ltd Companies

    • Limited Capital Raising: Cannot raise money from the public.
    • Restricted Growth: Expansion depends on internal funds and private investments.

    2. Public Limited Company (Ltd)

    A Public Limited Company (PLC) is a business entity that can offer shares to the general public and is listed on a stock exchange. It is ideal for large businesses that need significant capital.

    Key Features of a Public Ltd Company

    1. Unlimited Shareholders: Requires a minimum of 7 shareholders but has no upper limit.
    2. Freely Transferable Shares: Shares can be bought and sold on stock exchanges.
    3. Large-Scale Capital Raising: Can raise significant funds from public investors and institutions.
    4. Higher Regulatory Compliance: Must follow strict rules set by corporate laws, SEBI (if listed), and financial authorities.
    5. Board of Directors & AGM: Must hold Annual General Meetings (AGMs) and appoint a board of directors.
    6. Limited Liability: Shareholders are only liable for the amount they invest.

    Advantages of Public Ltd Companies

    • Huge Capital Raising: Can raise funds from millions of investors.
    • Increased Market Trust: Being public enhances credibility and transparency.
    • Share Liquidity: Investors can easily buy or sell shares.

    Disadvantages of Public Ltd Companies

    • Loss of Control: Founders may lose majority control due to multiple shareholders.
    • High Compliance Costs: Strict regulations, audits, and public disclosures.
    • Risk of Hostile Takeovers: Shares being publicly traded can lead to unwanted ownership changes.

    Key Differences Between Private and Public Companies

    A Private Limited Company is ideal for startups, family businesses, and privately held enterprises that prefer ownership control with minimal regulatory requirements.

    A Public Limited Company is suitable for large corporations that require substantial funding, wider investor participation, and stock market listing.

    The decision between Pvt Ltd and Ltd depends on the company’s funding needs, growth plans, and compliance capacity.