What is Irredeemable Debentures?
Irredeemable debentures are a type of debenture that cannot be redeemed during the lifetime of the company. Investors can only redeem if the company is winding up. The debenture holders enjoy an interest in these instruments throughout the life of the company. Nowadays, no companies are issuing irredeemable debentures in India.
These debentures are also called perpetual debentures or perpetual bonds. This is because these instruments do not have any redemption or maturity date. The company does not specify any redemption date at the time of issue. However, there are rare circumstances that the issuing company may want to repay the borrowed amount.
Companies use this method to raise finance because it is cost-effective. They only have to pay fixed interest on the debt instrument as per the legal contract terms. Sometimes, the issuers also have a call option on these debentures. This may be set for every five years or more, depending on the requirement.
Features of Irredeemable Debentures
The following are the main features of irredeemable debentures –
- Maturity Date: These debentures do not have any maturity date or redemption date. However, issuers have the right to call back if they are callable debentures, and the company mentions the same in the contract.
- Coupon Payment: The holders receive coupon payments on these debentures forever, i.e. till the issuer redeems the debentures.
- Risk: These instruments come with high liquidity risk as they cannot be redeemed easily.
- Insolvency: In case of dissolution, the holders with this instrument will receive their payments before the equity investors.
How do Irredeemable Debentures Work?
The irredeemable debenture is an agreement between the issuer and the investor. It also consists of the promise to pay interest to the holder. In case of a company’s insolvency, these debentures ensure that the company’s lenders are repaid first.
Let us understand with the help of an example.
Suppose a manufacturer enters into an irredeemable debenture agreement with a lender for a fixed amount. The manufacturer uses the borrowed money and maintains a healthy cash flow. As per the agreement, the manufacturer cannot sell its premise and high-end equipment without lenders’ consent or before repaying the borrowed amount.
Thus, in case of dissolution, the company pays the irredeemable debenture holder and then proceeds to sell its premise and pay off other creditors.
Advantages and Disadvantages of Irredeemable Debentures
The following are the advantages for issuers –
- It is a cost-effective method to raise finance for the company in the long term.
- It helps to raise significant capital requirements and allows grasping bigger projects with a longer time frame.
- Issuers can avoid capital market risks by issuing these instruments.
- If the issuer issues these debentures with a callable feature, they can redeem the bonds under favourable economic conditions or interest rates.
The following are the advantages for investors –
- The interest payments on these debentures serve as a steady and regular income for investors.
- In case of dissolution or liquidation, the investors are guaranteed to receive payments.
- It saves investors from the hassle of reinvesting.
The following are the disadvantages for issuers –
- Issuers have to pay interest until the redemption.
- These debentures do not follow a favourable or optimized capital structure.
The following are the disadvantages for investors –
- Investors’ funds are blocked for a long time. This prevents them from investing in other options.
- Sometimes issuers take advantage of the callable feature of these debentures and repurchase them. It results in zero or negligible profit for investors.
- Investors are exposed to insolvency risk for an indefinite time frame and other risks similar to an equity holder.
Frequently Asked Questions
Generally, any corporate or government that is looking to raise finance from the public can issue debentures. However, no company can issue irredeemable debentures in India.
No company can issue irredeemable debentures in India.
The primary difference between the two is the repayment feature. For irredeemable debentures, a company cannot repay the loan for a very long time or until it winds up. It only makes interest payments for a lifetime to the debenture holder. In contrast, redeemable debentures have a written agreement that mentions how and when the company will repay the principal amount to the debenture holder.