The benefits of Debentures to Investors and Companies

Debentures have certain advantages and disadvantages to both investors and companies. Both investors and companies have to weigh both the advantages and disadvantages when making a decision. This article explains the features, advantages, and disadvantages of dentures.

What is Debentures?

This is a long-term debt instrument that a company issue for the public members to subscribe. It is a borrowed capital to the issuing company. Therefore, debenture holders are creditors to the company. The holders entitle to the fixed interest and principal amount at the due date. They receive their interest irrespective of whether the company makes a profit or not. However, the holders are ahead of payment of dividend to the shareholders. During the liquidation of a company, they rank ahead of shareholders for settlement. So, the holders are not receiving dividends and also don’t have voting right.

Types of debentures

The major types include:

  • Redeemable and non-redeemable
  • Convertible and non-convertible
  • Secured and unsecured
  • Registered and bearer

Redeemable and non-redeemable

Redeemable debentures repaid at the agreed time. While irredeemable debentures are not repaid during the lifetime of the company unless the company is liquidated.

Convertible and non-convertible

Convertible debentures can convert into shares based on the agreed terms and conditions. While non-convertible cannot convert into shares.

Secured and unsecured

Secured debentures secured by underlying assets of the company. However, unsecured debentures are not secured by any asset of the company. Therefore, unsecured debentures receive higher interest than secured. An unsecured is also called a naked debenture.

Registered and bearer

Registered debentures involve register of the holder’s credentials like name, residential address, bank details, and others with the issuing authority. Meanwhile, bearer debentures do not contain registration of holder’s credentials. Under registered, the investors inform the company that it has being transferred to another person for changes of credentials. While no need to change investor’s details under bearer debentures. the accumulated interest is paid with the exchange of the coupon attached to the certificate.

Characteristics of debentures

The features of include the following:

  • The debenture holders entitle to fixed interest or return on investment irrespective of whether the company makes profit or loss.
  • The holders have no voting right in the organization.
  • Investment in it secured by certain underlying assets of the company.
  • It is a low-risk investment.
  • The holders have a preference ahead of shareholders for repayment of their investment in the case of the company’s liquidation.
  • They have the right to take legal action if the company defaults to fulfill its obligations.

Read Also: The benefits of Investing in Equity Shares to Investors

Advantages

  1. Preferred investment option: The investors preferred investing in it because of its security and safety.
  2. Less expensive: It is less expensive to the company because the rate of interest to pay on debenture is less than the rate of return (dividend) to pay on shares (both equity and preference shares).
  3. Preservation of control: Raising funds through this source does not dilute the existing control of the organization.
  4. Low investment risk: Investing in it attract low investment risk because the company pays fixed interest at an agreed time irrespective of whether the company makes a profit or not.
  5. Tax Advantages: Raising capital through this source helps the company to reduce tax liability. Because interest paid on debenture is an allowable expense in the determination of taxable income.
  6. Control of overcapitalization: The company can use it to control overcapitalization by redeeming the redeemable types of debentures.
  7. Conversion to shares: The holders can turn to the shareholders or owners of a company by converting convertible debentures to equity shares.

Disadvantages

  1. No voting right: The debenture holders have no voting right in deciding the management of the company.
  2. Unsuitable for some companies: The companies with fewer non-current assets find it difficult to raise capital through debentures because most debentures are secured by certain underlying assets.
  3. Liquidation of the company: The investors can file for the liquidation of a company if the company is unable to repay the principal of redeemable debentures at the agreed repayment period.

Conclusion

In conclusion, investing in debentures has its advantages and disadvantages to investors. Raising capital through it also has advantages and disadvantages to the companies. Both investors and companies have to weigh both the advantages and disadvantages when making a decision.

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