Debenture is a long-term financial instrument that represents a loan made by an investor to a borrower, typically a corporate entity. It is issued under a formal agreement, which stipulates the terms of the loan, including the interest rate, repayment schedule, and the rights and obligations of both the issuer and the debenture holder.
Debentures are usually Secured or Unsecured:
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Secured Debentures:
These are backed by specific assets of the company, providing assurance to debenture holders that they can claim these assets in the event of default.
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Unsecured Debentures:
These are not backed by any specific assets, making them riskier for investors.
Importance of Debentures in Subsidiary Companies:
Subsidiary companies are entities that are controlled by a parent company, typically holding a majority of shares.
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Capital Raising
Subsidiary companies often require funds for various purposes, such as expansion, acquisition of assets, or working capital. Issuing debentures provides a means of raising capital without diluting the ownership of the parent company. This is particularly advantageous for subsidiaries that may not have easy access to equity markets.
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Fixed Cost of Financing
Debentures typically carry a fixed interest rate, which allows subsidiary companies to predict their financing costs accurately. This predictability aids in financial planning and budgeting, enabling the subsidiary to manage its cash flows effectively.
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Flexibility in Financing
Debentures offer flexibility regarding maturity periods and repayment schedules. Subsidiary companies can structure their debenture issues to align with their cash flow needs, allowing for better financial management.
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Tax Benefits
Interest payments on debentures are tax-deductible, which can enhance the financial efficiency of subsidiary companies. This tax advantage makes debt financing more attractive compared to equity financing.
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Attraction of Diverse Investors
Issuing debentures can attract a wide range of investors, including institutional investors who prefer fixed-income securities. This diversification of the investor base can enhance the subsidiary’s financial stability and reputation in the market.
Regulatory Framework Governing Debentures in Subsidiary Companies:
In India, the issuance and management of debentures by subsidiary companies are regulated under the Companies Act, 2013, as well as the Securities and Exchange Board of India (SEBI) regulations. Key provisions are:
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Issuance of Debentures
Section 71 of the Companies Act governs the issue of debentures, stipulating that a company may issue debentures subject to the conditions specified in the act. Companies must pass a resolution to approve the issue of debentures, which may require obtaining consent from the shareholders in certain cases.
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Debenture Trust Deed
Debenture trust deed is a legal document that outlines the terms and conditions of the debenture issue, including the rights of debenture holders and the obligations of the issuing company. It must be executed in favor of a trustee representing the debenture holders to safeguard their interests.
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Redemption of Debentures
Companies are required to outline a clear redemption plan for debentures in their issuance documents, specifying the maturity period and repayment terms. Provisions for the creation of a debenture redemption reserve may also apply, which is a fund set aside for the repayment of debentures upon maturity.
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Interest Payments
Subsidiary companies must ensure timely payment of interest to debenture holders as stipulated in the debenture agreement. Failure to do so can lead to legal consequences and impact the company’s creditworthiness.
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Filing Requirements
Subsidiary companies must comply with filing requirements under the Companies Act, including submitting necessary forms to the Registrar of Companies (ROC) concerning the issuance of debentures.
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Regulations by SEBI
If the debentures are listed on stock exchanges, the subsidiary company must also comply with SEBI regulations, which impose additional disclosure and reporting requirements to protect investors’ interests.
Types of Debentures Suitable for Subsidiary Companies:
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Convertible Debentures
These debentures give holders the right to convert their debentures into equity shares of the company after a specified period. This option can be attractive to investors, as it allows them to participate in the company’s equity upside.
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Non-Convertible Debentures
These debentures cannot be converted into equity shares and typically offer higher interest rates compared to convertible debentures, compensating investors for the lack of conversion rights.
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Redeemable Debentures
These debentures are issued with a specified maturity date, at which point the company must repay the principal amount to the debenture holders. This type allows for better cash flow management.
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Irredeemable Debentures
Irredeemable debentures do not have a fixed redemption date and may remain outstanding indefinitely. They can provide a steady income stream for the issuing subsidiary but may be less attractive to investors due to their uncertain repayment timeline.
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