Issue and Redemption of Debentures

Debentures are a common tool used by companies to raise long-term capital without diluting ownership through equity shares. The process of issuing debentures involves selling them to investors who, in return, receive regular interest payments and the promise of repayment of the principal at the maturity date. The redemption of debentures refers to the repayment of the borrowed amount to debenture holders after the debenture’s tenure.

Issue of Debentures

The process of issuing debentures is an important step in corporate financing, as it enables companies to meet their capital needs without affecting their equity structure. Below are the various aspects of issuing debentures:

Methods of Issuing Debentures:

Debentures can be issued in different ways depending on the needs of the company and the preferences of the investors. The primary methods:

• Public issue:

Companies can offer debentures to the public by issuing a prospectus that details the terms and conditions of the debenture. The public can then apply to purchase these debentures, just like in a public offering of shares.

• Private Placement:

Debentures can be issued privately to a select group of investors, usually large institutions or high-net-worth individuals. This method is faster than a public issue and involves fewer regulatory requirements.

• Rights issue:

Existing shareholders are offered the right to subscribe to debentures in proportion to their existing shareholding. This method ensures that current shareholders have an opportunity to participate in the company’s debt issuance.

• Preference issue:

Debentures can be issued to selected investors (often existing stakeholders) with preferential terms, such as higher interest rates.

Types of Debentures Issued:

Companies issue different types of debentures based on their capital requirements and investor preferences:

• Secured Debentures:

These debentures are backed by specific assets of the company. In the case of default, secured debenture holders have a claim on these assets.

• Unsecured Debentures:

These are not backed by any collateral and are riskier for investors. However, they may offer higher interest rates to compensate for the added risk.

• Convertible Debentures:

These can be converted into equity shares after a certain period or at the discretion of the debenture holder. This gives the holder the potential to benefit from any increase in the company’s share price.

• Non-Convertible Debentures:

These cannot be converted into shares and remain a fixed income instrument throughout their tenure.

Key Elements of Debenture Issuance:

When issuing debentures, companies must clearly outline the following key terms:

• Interest Rate:

Interest rate is usually fixed and is paid to debenture holders periodically (annually or semi-annually). The rate reflects the company’s creditworthiness and the overall market conditions.

• Maturity Period:

This is the time frame over which the debenture will exist, typically ranging from 5 to 20 years. At the end of the maturity period, the principal amount is repaid to debenture holders.

• Redemption Terms:

These outline when and how the debentures will be redeemed, which may include specific options like early redemption or repayment in installments.

• Issue Price:

Debentures can be issued at par (face value), at a premium (above face value), or at a discount (below face value). The issue price influences the yield that investors will earn.

Redemption of Debentures

Redemption refers to the repayment of the principal amount to debenture holders once the debenture matures. There are various methods of redemption, and the specific method is typically outlined in the terms of the debenture issue.

Methods of Redemption:

• Lump Sum Payment:

This is the most common method, where the company repays the entire principal amount to debenture holders at the maturity date in one single payment.

• Installment Payments:

Instead of paying the entire principal at once, the company repays a portion of the principal periodically over the debenture’s term. This reduces the financial burden at the time of maturity.

• Redemption by Purchase in the Open Market:

The company may buy back debentures in the open market before their maturity date if they are available at a lower price than face value. This allows companies to retire debt at a lower cost.

• Conversion into Shares:

If the debentures are convertible, they can be converted into equity shares of the company at a pre-determined rate. This method is attractive for investors who wish to switch from debt instruments to equity if the company performs well.

• Call and Put Options:

Some debentures come with a call option, allowing the company to redeem the debentures before the maturity date. Similarly, a put option allows the investor to demand early repayment from the company.

Sources of Redemption Funds:

Companies need to arrange for funds to redeem debentures. Common sources:

• Sinking Fund:

Many companies set up a sinking fund specifically for debenture redemption. A portion of the company’s profits is periodically transferred to this fund, ensuring that the company has sufficient resources to repay the debentures at maturity.

• Fresh Issue of Debentures or Shares:

Company may issue new debentures or shares to raise funds for the redemption of existing debentures. This method helps companies avoid liquidity crunches at the time of redemption.

• Profit Reserves:

If a company has sufficient profits and reserves, it can use these resources to redeem debentures. This is a common practice among financially sound companies.

• Loans from Banks or Financial Institutions:

If the company does not have sufficient internal resources, it may take out a loan to redeem debentures. While this transfers the debt from debenture holders to financial institutions, it ensures that the debentures are repaid on time.

Premium on Redemption:

In some cases, companies agree to redeem debentures at a price higher than their face value. This is known as redemption at a premium. The premium acts as an additional incentive for investors to subscribe to the debentures at the time of issue, especially if the interest rate is relatively low.

Legal Requirements for Redemption:

The Companies Act, 2013, governs the redemption of debentures in India. Companies are required to comply with certain regulations, such as:

• Creation of Debenture Redemption Reserve (DRR):

Companies must set aside a portion of their profits in a Debenture Redemption Reserve (DRR) to ensure they have funds available for repayment. However, certain classes of companies are exempt from this requirement.

• Maintenance of Records:

Companies must maintain accurate records of debenture holders and the terms of redemption. These records are essential for transparency and regulatory compliance.