What is Redemption of Debentures?
Redemption of debentures refers to the re-payment of debt that the company raised in the form of debentures. The company issues debentures which have fixed maturity date. At the time of maturity, the company repays the debenture holders for the investment made by them. The price the company repays is above or below, or equal to, the face value of debentures. Therefore, when the company issues debentures, it has to adhere to all the terms and conditions in the prospectus.
Redemption of debentures discharges the company from its liability and removes it from the balance sheet. Also, this is a major transaction for the company because it involves a significant amount of money. This is the reason the company also creates a Debenture Redemption Reserve (DRR) account. It only uses this reserve for the redemption of debentures.
Value of the Debenture at the Time of Redemption
At the time of redemption of debentures, the company can redeem them at a value that it decides at the time of issue. The following are various values at which the company can redeem the debentures –
- At Par: The redemption value is equal to the face value of debentures.
- At Premium: The redemption value is higher than the face value of debentures. For instance, if the face value of the debenture is INR 100, the redemption value can be INR 120, as decided at the time of issue.
- At Discount: The redemption value is lower than the face value of debentures. For instance, if the face value of the debenture is INR 100, the redemption value can be INR 90 as decided at the time of issue.
Methods of Redemption of Debentures
The following are multiple options for the redemption of debentures to ensure that the interest of debenture holders and the company is not endangered.
Lump Sum on the Debenture’s Maturity
This is a simple method of debenture where the company makes one single payment to the debenture holders at the time of maturity as per the terms of issue. If the debentures are not redeemed at a discount or premium, then the lump sum amount is equal to the principal amount. Also, the company shall prepare itself for the upcoming payments. They must make suitable investments and arrange finances to be able to meet their commitments in time, along with the funds set aside under DRR.
Furthermore, the debenture holders must be careful about the liquidity and solvency conditions of the company. Because the redemption of entire amount is possible only when the company is financially strong and has a comfortable liquidity position.
Instalments After the Maturity Date
Under this redemption process, the company agrees to redeem the debentures through instalments. These instalments are pre decided at a particular date when issuing debentures. The total liability amount is divided by the total number of years. In other words, this process is like repaying a loan in instalments where the payment of principal amount happens along with interest. Thus, this mode eases the burden of the company to pay off the debt and avoids raising an ad hoc amount upon maturity of the debentures.
Purchase of the Debenture in Open Market
The company can purchase debentures from the open market when the units are traded on the regulated stock exchange. This will save them from the hassle of administrative paperwork. Also, these debentures are traded at a discounted price in the market. Thus, the company can gain from these purchases. Also, when the company’s liquidity is high, it can go for full or partial redemption.
For instance, the company ABC issues debentures of INR 50 crore for five years and gets listed on the stock exchange. After two years, the company purchases INR 20 crores value of debentures when they have sufficient liquidity and reduce their redemption liability.
Conversion of Debentures into New Debentures or Equity Shares
This is the most common mode for redeeming debentures by converting them into equity shares or preference shares. In this case, the company has to prefix the term ‘convertible’ to the debentures in their balance sheet. It provides adequate information to the shareholders about the impending addition to the company’s share capital. The company issues these additional shares or debentures at face value, discount or premium. Therefore, the company discharges the total liability with this conversion.
Call Option and Put Option
Some companies issue debentures with a call option or put option, or both for redemption. The call option gives the company the right to purchase the debenture on or before the maturity date at a specific price. On the other hand, the put option provides the debenture holders with the right to sell back the debenture to the company at a specific price on or before the maturity period.
Debenture Redemption Reserve
The debenture redemption reserve is also known as a sinking fund. The company creates this fund by allocating some of its profits to redeem debentures at maturity and then allocating this amount to appropriate investments. As per the Indian Companies Act 1956, the companies that issue debentures must create this reserve account and maintain at least 25% of the debenture issue capital. Thus, the main objective of this reserve is to protect the interest of debenture holders.
Frequently Asked Questions
The companies issue debentures to the public to raise capital for their growth and expansions. The major advantage of this method is the cost of capital is less expensive, as the cost of issuing equity is higher than the cost of debt. Also, the company redeems after a long period of time. Thus, the company has adequate time to meet its obligations.
The common methods for the redemption of debentures are payment in a lump sum or issuing convertible debentures (converting debentures to equity shares)
A Debenture Redemption Reserve (DRR) is a fund that companies build to protect investors’ interests. As per the Companies Act 1956, the company has to maintain 25% of the outstanding debenture capital in this account.
Yes, the DRR corpus can be invested in notified securities to earn profit or interest. Also, the income generated from this investment shall be included in the DRR and utilized for the redemption of debentures.
The company has to transfer the excess DRR after the redemption of debentures to the capital reserve account.
Usually, the tenure does not exceed ten years from the date of issue. However, in special cases (funding big infra projects), the tenure extends up to 30 years.