Debentures

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Debentures are alternative way of raising money for the company. Strictly speaking, it is not a capital, but a loan to the company. It is often secured by either a change on assets of floating charge on all assets.

For this case bubble milk-tea business has grown tremendously, and the director plan to set-up 5 stalls and its capital needed is estimated to be around RM250.000. Debentures are one of the common long term sources of finance. They normally carry a fixed interest rate and a certain date of maturity. There are several advantages of using debentures as a source of long term finance but at the same time they come along with certain disadvantages also. Following are some advantages and disadvantages of debentures from the point of view of a company.

Advantages of debentures :

No Dilution of Control: Issuing of debentures does not affect control of the existing shareholders or the owners of the company. If the same fund is raised using equity finance, the control of existing shareholders would dilute accordingly.

Benefit of Leverage: By involving debt in a company making profits, the management can always maximize wealth of the shareholders. Let’s take an example, suppose the internal rate of return of a company is 15%(RM 37.500) against a 12%(RM 30.000) rate of interest which is paid to the debenture holders. The extra 3%(RM 7.500) which is earned out of the money of debenture holders is shared by the equity shareholders. This is how involvement of debentures can lead to welfare of the shareholders. All this is true under a handsome rate of return on the company’s projects which are at least higher than the interest rate offered on debentures.

Disciplinary Effect: The burden of interest is fixed in debentures irrespective of the business profits, operational situations etc. This makes the entrepreneur all the more cautious and committed towards managing the business and maintaining the cash flows effectively. It is because a severe...
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