Merits & Demerits of Debenture

Merits of debenture

a)    Raising funds without allowing control over the company: The debenture holders do not have right to vote.  Thus,  they can not intervene in the management of the company.  The company can raise funds without the control of debenture holders.

 



b)    Reliable source of long term finance: Debentures are ordinarily issued for a fixed time. The company may use the funds raised by issuing debentures.  It facilitates long-term planning of the company.

 

c)     Tax Benefits: Interest paid on debentures is treated as an expense.  The interest  is charged to the profits of the company. It results into reduction in tax liability of the company.

 

d)    Investors’ Safety: Generally debentures are secured. When the company is winding-up, they are repayable before any payment is made to the shareholders. Interest on debentures has to be paid whether the company is earning profit or loss.

 

Demerits of debenture

1)    As you have understood that the interest on debentures have to be paid every year whether the company earns profits or incurs losses. In case of losses, payment becomes a burden for the company.

 

2)    Generally the debentures are secured. The company creates a charge on its assets in favour of debenture holders. If company does not own sufficient amount of assets, the company may not be in a position to issue debentures. If the assets of the company are mortgaged, these assets can not be issued for further borrowing.

 

3)    Debenture-finance enables a company to trade on equity. If the company issues very large number of debentures, it may have adverse impact on shareholders.  The shareholders may get frustrated.  As a result, the  value of shares may fall.

 

4)    It may be a burden on the company during recession. At the time of recession, the profits of the company may decline. In such cases, it may be difficult to pay interest on debentures. The interest may keep on accumulating. The accumulation of very large amount of interest may lead to the closure of the company.

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