Debentures are creditorship securities which provide funds to the company on loan basis rather than on capital basis. A debenture may be defined as an acknowledgment of debt by a company. The debenture-holders are entitled to periodical payment of interest at a fixed rate ad are also entitled to redemption of their debentures as per terms of debenture issue. The debentures holders are the creditors of the company. Their rights depends upon the type of debentures issued by the company.

Features of Debentures. The debentures have the following features:

(i)    Debentures carry a fixed rate of interest every year. Thus, there is a guarantee of return.
(ii)    Debentures can be redeemed as per the terms of their issue.
(iii)    Debentures are generally secured by change (mortgage) on the company’s assets which could be sold in case of default by the company.
(iv)    Debenture holders don’t carry and voting right and so they can’t participate in the election of directors.

A company may issue the following types of debentures:

(i)    Secured and Unsecured Debentures. Secured debentures represent the fixed or floating charge on the assets of the company. Unsecured debentures also known as simple or naked debentures, do not carry any charge or security on the assets of the company.

(ii)    Redeemable and Irredeemable Debentures. In case of redeemable debentures, the company reserves the right of paying of the principal on or after a particular date. In case of irredeemable or perpetual debentures, the company does not fix any date by which they would be redeemed and the holders of such securities cannot demand payment from the company so long as it is a going concern.

(iii)    Convertible and Non-convertible Debentures. The convertible debentures can be converted into equity shares of the company after the expiry of the specified period. but non-convertible debentures cannot be converted into equity shares. In the recent years, the proactive of issuing debentures which are partially convertible into equity shares has gained momentum.

Merits of Debentures. Debentures offer the following advantages:

(i)    Debentures are preferred by the investors who give wattage to safety of principal and a continuous income on their principal.

(ii)    Debenture-holders do not posses voting rights. They do not weaken the control of existing shareholders.

(iii)    Debentures offer an opportunity to the company to trade on equity and there by increase the return of equity shareholders.

(iv)    Debentures provide financial flexibility as they can be redeemed when the company has surplus funds.
(v)    Interest paid on debentures is deductible form the profits of the company or income tax purpose. Thus, the company enjoys tax benefit by issuing debentures.

Demerits of Debentures. The issue of debentures is associated with the following drawbacks:

(i)    Debentures require the company to bear a fixed burden of interest every year irrespective of profits earned. if a company does not have stable earnings, this liability will create problems.

(ii)    Debenture holders prefer safety of their investments ad so they like secured debentures. A company which is not willing to offer its assets as security may not be able to raise finance by issuing debentures.

(iii)    If the capital structure of a company is loaded heavily with debentures, banks and other financial institutions do not show a favorable attitude towards the company.

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