Mode of Discharge of Purchase Consideration

When a business entity, such as a partnership firm, is converted into a limited company, the new company is required to settle or “discharge” the purchase consideration agreed upon. The discharge of purchase consideration refers to the method by which the purchasing company pays the agreed amount to the seller (partners of the firm). This discharge can be done in various modes, including cash, shares, or debentures.

The modes of discharge are broadly categorized as follows:

1. Discharge through Cash Payment

In this method, the purchasing company pays the entire or part of the purchase consideration in cash to the selling partners. This mode is simple and involves direct cash transactions.

Features

  • Suitable for quick settlements.
  • Immediate liquidity is provided to the selling partners.
  • Often used when the purchasing company has sufficient cash reserves.

Example

If the purchase consideration is ₹10,00,000 and the company pays ₹6,00,000 in cash, the balance can be settled using other modes.

2. Discharge through Equity Shares

The purchasing company can issue equity shares to the partners of the selling firm as part or full payment of the purchase consideration. Equity shares represent ownership in the company, providing partners with voting rights and dividends.

Features

  • Allows the selling partners to become shareholders in the new company.
  • Helps the purchasing company retain cash.
  • Suitable when the firm being acquired has long-term strategic importance.

Example

If the purchase consideration is ₹10,00,000, the company may issue 10,000 equity shares at a face value of ₹100 each to the selling partners, thereby discharging the entire amount through equity shares.

3. Discharge through Preference Shares

In some cases, the purchasing company may issue preference shares instead of equity shares. Preference shares offer a fixed rate of dividend but usually do not carry voting rights.

Features

  • Preference shares provide a fixed return to the selling partners.
  • Preferred when the selling partners are more interested in stable income than ownership control.
  • Helps in maintaining control with the existing shareholders of the purchasing company.

Example

If the purchase consideration is ₹10,00,000, the company may issue 1,000 preference shares at ₹1,000 each with a dividend rate of 8% to the partners.

4. Discharge through Debentures

The purchasing company may issue debentures to the selling partners. Debentures are debt instruments that provide a fixed interest rate and are redeemable after a specified period.

Features

  • Ensures a regular interest income to the selling partners.
  • Does not dilute ownership control of the purchasing company.
  • Suitable when the purchasing company prefers to treat the settlement as a debt obligation rather than ownership transfer.

Example

If the purchase consideration is ₹10,00,000, the company may issue 1,000 debentures at ₹1,000 each, carrying a fixed interest rate of 10%.

5. Combination of Cash and Securities

Often, the purchasing company may use a combination of cash, equity shares, preference shares, and/or debentures to discharge the purchase consideration. This method provides flexibility to both parties and allows for better negotiation terms.

Example

Suppose the purchase consideration is ₹20,00,000. The discharge may be structured as follows:

  • Cash payment: ₹5,00,000
  • Equity shares: ₹10,00,000 (10,000 shares at ₹100 each)
  • Debentures: ₹5,00,000 (500 debentures at ₹1,000 each with 9% interest)

This combination ensures liquidity (through cash), ownership interest (through equity shares), and fixed income (through debentures) for the selling partners.

6. Discharge through Business Assets

In some cases, the purchasing company may transfer specific business assets, such as property, plant, or machinery, to the selling partners in lieu of cash or securities. This method is less common but may be used in special circumstances.

Features

  • Suitable when the selling partners are interested in specific assets rather than monetary payment.
  • Helps the purchasing company reduce excess or non-essential assets.
  • May involve complex valuation and legal formalities.

Comparison of Different Modes

Mode Description Advantages Disadvantages
Cash Payment Full/partial settlement in cash Quick settlement, easy to understand Requires large cash reserves
Equity Shares Issue of ownership shares Provides ownership interest to sellers Dilutes control of existing shareholders
Preference Shares Issue of fixed dividend shares Fixed income for sellers, no dilution No voting rights for sellers
Debentures Issue of interest-bearing debt instruments Fixed income, no dilution Increases debt burden of purchasing company
Combination Mixture of cash, shares, and/or debentures Flexible, suits both parties May involve complex structuring
Business Assets Transfer of specific assets Reduces excess assets Involves complex valuation

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