Warrants and Debentures: Meaning, Features, Types, Advantages and Limitations

Warrants

A warrant is a financial instrument that gives the holder the right to purchase a fixed number of a company’s ordinary shares at a predetermined price within a specified period. It gives only a right to buy, not an obligation.

Characteristics of Warrants

1. Exercise Price – The fixed price at which the warrant holder can buy the shares. 
2. Exercise Ratio – The number of shares that can be purchased through one warrant. 
3. Expiration Date – The last date on which the warrant can be exercised. 
4. Detachability – Warrants may be detachable and traded separately from the security with which they were issued. 
5. Right, not obligation – The holder can choose whether or not to exercise the warrant. 

Why Companies Issue Warrants

1. Sweetening Debt – Warrants are added to bonds or debentures to make them more attractive to investors. 
2. Deferred Equity Financing – Helps the company raise equity capital at a future date. 
3. Future Cash Inflow – When warrant holders exercise their warrants, the company receives funds. 

What are debentures?

Debentures are creditorship securities that represent the long-term debt of a company. A debenture is a written instrument issued by a company under its common seal acknowledging that a certain amount has been borrowed from a person or a group of persons. It is therefore a security issued by the company against a loan or debt raised.

A public limited company can raise funds through debentures after obtaining the certificate of commencement of business, provided such borrowing is permitted by its Memorandum of Association. The Company’s Act does not specifically define the term debenture.

Like shares, debentures are issued in convenient units representing equal parts of the total loan raised by the company. They are generally secured by the company’s assets through either a fixed charge or a floating charge. Debenture holders are usually paid interest at fixed intervals, commonly every six months, and the company repays the principal amount on the maturity date according to the terms of issue.

Debentures may be issued to the public at par, at a premium, or at a discount. The holders of debentures are creditors of the company, not owners. Therefore, they do not enjoy voting rights in the management of the company. However, their claims are given priority over both preference shareholders and equity shareholders. The rights of debenture holders depend upon the type and terms of the debentures they hold.

Features of Debentures

1. Interest Rate – Debentures carry a fixed rate of interest, which is payable at regular intervals, regardless of the company’s profits. 
2. Maturity – Debentures are issued for a specified period and are repayable on a fixed maturity date. 
3. Redemption – The company repays the debenture amount on maturity. Common methods include:
• Sinking Fund – A fund created over time to ensure repayment.
• Buy-back / Call Provision – The company has the option to redeem debentures before maturity. 
4. Indenture (Debenture Trust Deed) – A legal document that states the terms of issue, rights of debenture holders, interest payment, security, and redemption conditions. 
5. Security – Debentures may be secured by the company’s assets through a fixed charge or floating charge. Some debentures may also be unsecured. 
6. Yield – Refers to the return earned by debenture holders through interest and any gain on redemption. 
7. Claims on Assets and Income – Debenture holders are creditors of the company. They have priority over shareholders in receiving interest and repayment of capital, and their claims on assets come first at the time of winding up.

Types of Debentures

Debentures may be classified into the following types:

1. Redeemable and Irredeemable Debentures

Redeemable debentures are those that are repayable by the company after a specified period mentioned in the terms of issue. They may also be redeemed earlier at the option of the company by giving notice to debenture holders or through installments.

Irredeemable debentures are those for which no fixed date of repayment is specified. The debenture holders cannot demand repayment during the company’s lifetime. They become repayable only on the winding up of the company or when the company defaults in paying interest. These are also known as perpetual debentures.

2. Secured and Unsecured Debentures

Secured debentures are backed by the assets of the company. They may carry:

• a fixed charge on specific assets, or 
• a floating charge on all or general assets of the company. 

Unsecured debentures are not backed by any charge on company assets. They rely only on the company’s creditworthiness and are also called simple or naked debentures.

3. Registered and Bearer Debentures

Registered debentures are recorded in the company’s register along with the holder’s name, address, and details of holdings. Transfer requires a properly executed transfer deed, and interest is paid only to the registered holder.

Bearer debentures are transferable simply by delivery without notifying the company. The company keeps no record of holders. Interest is received by the person presenting the attached coupon. These are known as debenture coupons.

4. Convertible and Non-Convertible Debentures

Convertible debentures give holders the right to convert their debentures into equity shares or preference shares after a specified period.

Non-convertible debentures cannot be converted into shares and remain debt instruments until redemption.

A company may also issue partly convertible debentures, where only a portion of the debenture amount is converted into shares and the balance remains redeemable as debt.

Advantages of Debentures

1. Less Costly Source of Finance – Debentures are generally cheaper than equity because the company pays a fixed rate of interest without sharing profits or ownership. 
2. No Dilution of Control – Debenture holders are creditors, not owners, so issuing debentures does not affect the voting rights or control of existing shareholders. 
3. Fixed Interest Payment – The rate of interest is predetermined, which helps the company plan its financial obligations with certainty. 
4. Reduced Real Burden of Repayment – During inflation or over time, the real value of repayment may reduce, making the burden lighter for the company. 

Limitations of Debentures

1. Obligatory Payment of Interest – Interest must be paid regularly whether the company earns profits or not. 
2. Financial Risk – Excessive borrowing through debentures increases the company’s debt burden and financial risk. 
3. Cash Outflows – Regular interest payments and repayment of principal involve continuous cash outflow. 
4. Restrictive Covenants – Debenture trust deeds may impose conditions or restrictions on the company’s financial and business decisions.