Understanding Debentures and Corporate Finance
Debentures
Debentures are one of the principal sources of raising borrowed capital to meet long and medium term financial needs. Over the years debentures have occupied a significant position in the financial structure of the companies. The term debenture has come from the Latin word ‘debere’ which means to ‘owe’. The term debenture has not been defined clearly under Companies Act. Sec 2(30) of the Companies Act 2013, only states that, ‘the word debenture includes debenture stock, bonds and any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not’. Under the existing definition, debenture includes debenture stock. Debenture means a document which either creates or acknowledges debt. Ordinarily, debenture constitutes a charge on some property of the company, but there may be a debenture without any such charge. Palmer defines: “A debenture as an instrument under seal evidencing debt, the essence of it being admission of indebtedness.” Topham defines: “A debenture is a document given by a company as evidence of debt to the holder, usually arising out of loan, and most commonly secured by charge.” According to the above definitions, debenture is an evidence of indebtedness. It is an instrument issued in the form of debenture certificate, under the common seal of the company.
Features
- Promise: Debenture is a promise by company that it owes specified sum of money to holder of the debenture.
- Face Value: The face value of debenture normally carries high denomination. It is ₹100 or in multiples of ₹100.
- Time of Repayment: Debentures are issued with the due date stated in the debenture certificate. The principal amount of debenture is repaid on maturity date.
- Priority of Repayment: Debentureholders have a priority in repayment of debenture capital over the other claimants of company.
- Assurance of Repayment: Debenture constitutes a long term debt. They carry an assurance of repayment on due date.
6. Interest: A fixed rate of interest is agreed upon and is paid periodically in case of debentures. Payment of interest is a fixed liability of the company. It must be paid by company irrespective of the fact, whether the company makes profit or not.
7. Parties to Debentures:
- Company: This is the entity which borrows money.
- Trustees: A company has to appoint Debenture Trustee if it is offering Debentures to more than 500 people. This is a party through whom the company deals with debenture holder. The company makes an agreement with trustees, it is known as Trust Deed. It contains the obligations of company, rights of debenture holder, powers of Trustee, etc.
- Debenture Holder: These are the parties who provide loan and receive, ‘Debenture Certificate’ as an evidence.
8. Authority to issue debentures: According to the Companies Act 2013, Section 179(3), the Board of Directors has the power to issue debentures.
9. Status of Debenture Holder: Debenture Holder is a creditor of the company. Since debenture is a loan taken by company, interest is payable on it at fixed rate, at fixed interval until the debenture is redeemed.
10. No Voting Right: According to Section 71 (2) of the Companies Act 2013, no company shall issue any debentures carrying any voting right. Debenture Holder have no right to vote at general meeting of the company.
11. Security: Debentures are generally secured by fixed or floating charge on assets of the company. If a company is not in a position to make payment of interest or repayment of capital, the debenture holder can sell off charged property of the company and recover their money.
12. Issuers: Debentures can be issued by both private company and public limited company.
13. Listing: Debentures must be listed with at least one recognised stock exchange.
14. Transferability: Debentures can be easily transferred, through the instrument of transfer.
Importance of Corporate Finance
In the functional management of business enterprise, importance is given to production, finance, marketing and personnel activities. Among all these activities, utmost importance is given to financial activities. The importance of corporate finance may be discussed as follows –
- Helps in decision making: Most of the important decisions of business enterprise are determined on the basis of availability of funds. It is difficult to perform any function of business enterprise independently without finance. Every decision in the business is needed to be taken keeping in view of its impact on profitability. There may be number of alternatives but the management is required to select the best one which will enhance profitability. Business organisation can give green signal to the project only when it is financially viable. Thus corporate finance plays significant role in decision making process.
- Helps in Raising Capital for a project: Whenever a business firm wants to start a new venture, it needs to raise capital. Business firm can raise funds by issuing shares, debentures, bonds or even by taking loans from the banks.
- Helps in Research and Development: Research and Development must be undertaken for the growth and expansion of business. Detailed technical work is essential for the execution of projects. Research and Development is lengthy process and therefore funds have to be made available throughout the research work. This would require continuous financial support. Many a times, Company has to upgrade its old product or develop new product to attract the consumers. For this company has to conduct survey, market analysis, etc. which again requires financial support.
- Helps in smooth running of business firm: A smooth flow of corporate finance is needed so that salaries of employees are paid on time, loans are cleared on time, raw material is purchased whenever required, sales promotion of existing products is carried out smoothly and new products can be launched effectively
- Promotes expansion and diversification: Modern machines and modern techniques are required for expansion and diversification. Corporate finance provides money to purchase modern machines and technologies. Therefore finance becomes mandatory for expansion and diversification of a company.
- Managing Risk: Company has to manage several risks, such as sudden fall in sales, loss due to natural calamity, loss due to strikes, etc. Company needs financial aid to manage such risks.
- Replace old assets: Assets such as plant and machinery become old and outdated over the years. They have to be replaced by new assets. Finance is required to purchase new assets.
- Payment of dividend and interest: Finance is needed to pay dividend to shareholders, interest to creditors, banks, etc.
- Payment of taxes/fees: Company has to pay taxes to Government such as Income Tax, Goods and Service Tax (GST) and fees to Registrar of Companies on various occasions. Finance is needed for paying these taxes and fees.
Justify The Following Statement.
A company can issue a duplicate share certificate.
A Company can issue a duplicate share certificate in the following circumstances:
- If original share certificate has been defaced, mutilated or torn and is surrendered to the company.
- If it has been proved by the holder that the original share certificate is lost or destroyed.
- In case of loss of share certificate, the company puts up a notice in the newspaper to announce the loss of the share certificate.
- If the company does not get any response from the public within the specified time, then the company issues a duplicate share certificate.
- Duplicate share certificate should be issued within three months from the date of application.
- Duplicate share certificate should be issued within 3 months from the date of application with bold ‘duplicate share certificate’ marked on it.
Justify The Following Statement.
Fixed Capital Stays In The Business Almost Permanently.
Factors determining fixed capital requirements are:
- Fixed capital refers to capital invested for acquiring fixed assets.
- These assets are not meant for resale.
- Fixed capital is capital used for purchasing land and building, furniture, plant, and machinery, etc.
- Such capital is usually required at the time of the establishment of a new company.
- Existing companies may also need such capital for their expansion and development, replacement of equipment, etc.
Justify The Following Statement.
Financial markets acts as link between investor and borrower.
- The financial market is the market that brings together borrowers and lenders.
- The financial market attracts fund from investors by offering them a variety of schemes and then collected fund is diverted into the business organizations.
- People having surplus cash invested into financial market securities, the financial market provides finance then to businesses.
- Similarly, when the financial market generates income from investments in business, it shares with the investor.
- Thus, it is a valuable link between borrower and lender.
Justify The Following Statement.
Capital Market Is Useful For Corporate Sector.
- Capital Market is the market that provides loans for long-term periods. It is controlled by SEBI.
- It uses shares, debenture bonds, Mutual funds.
- The corporate sector issues these securities in the market and attracts saving from investors by offering them a variety of schemes. These savings become capital and get invested in the business.
- It is helpful to develop the corporate and industrial sectors.
- Thus, the capital market is useful for the corporate sector.
Justify The Following Statement.
Equity Share Capital Is Risk Capital.
- Equity shareholders have a claim over residual proceeds of the company.
- In the event of winding up, they are the last to be paid off after setting the claims of creditors and external liabilities.
- They have fluctuating returns and risk of fluctuating market value.
- Equity capital is permanent capital and not refunded during the lifetime of the company.
- Not having any assurance as regards dividend, repayment of capital Equity Capital becomes risk capital.
- Thus, it is rightly said, that equity capital is risk capital.