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Unit 3: Sources of Finance

The disadvantages of debenture financing are: Notes

1. The protective covenants associated with a debenture issue may be restrictive
2. Debenture financing enhances the financial risk associated with the firm.
These days, many companies are issuing convertible debentures or bonds with a number of
schemes/incentives like warrants/options etc. These bonds or debentures are exchangeable at
the option of the holder for ordinary shares under specified terms and conditions. Thus, for the
first few years these securities remain as debentures and later they can be converted into equity
shares at a predetermined conversion price. The issue of convertible debentures has distinct
advantages from the point of view of the issuing company. Firstly, such as issue enables the
management to raise equity capital indirectly without diluting the equity holding, until the
capital raised has started earning an added return to support the additional shares. Secondly,
such securities can be issued even when the equity market is not very good. Thirdly, convertible
bonds are normally unsecured and, therefore, their issuance may ordinarily not impair the
borrowing capacity. These debentures/bonds are issued subject to the SEBI guidelines notified
from time to time.
Public issue of debentures and private placement to mutual funds now require that the issue be
rated by a Credit Rating Agency Like CRISIL (Credit Rating and Information Services at India
Ltd.). The credit rating is given after evaluating factors like track record of the company,
profitability, debt servicing capacity, credit worthiness and perceived risk of lending.

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Caution Debenture interest and capital repayment are obligatory payments.

3.2.4 Types of Debentures

Debentures can be classified based on security against which it is placed and whether convertible
into shares or not.

Non-Convertible Debentures (NCDs)
These debentures cannot be convertible into equity shares and will be redeemed at the end of
the maturity period.

Example:ICICI offered for public subscription for cash at par 20,00,000, 16% unsecured
redeemable bonds (Debentures) of 1000 each. These bonds are fully non-convertible (i.e., the
investor is not given the option of converting into equity shares); interest payable half yearly on
June 30 and December 31, to be redeemed (paid back) on the expiry of 5 years from the date of
allotment. But ICICI has also allowed the investors, the option of requesting the company to
redeem all or part of the bonds held by them on the expiry of 3 years from the date of allotment,
provided the bond holders give the prescribed notice to the company.

Fully Convertible Debentures (FCDs)

These debentures will be converted into equity shares either fully at one stroke or in instalments.
The debentures may or may not carry interest till the date of conversion. The conversion will be
at a premium either fixed before hand or as per some formula. FCDs are very attractive to the
investors as their bonds are converted into equity shares at a price, which actually in the market
may be much higher.

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