Debentures is a type of debt which is issued by the company, the person who holds debentures receive regular interest and on maturity principal amount is repaid to debenture holders. Given below are some of the pros and cons of debentures –
Pros of Debentures
No Dilution of Ownership
One of the benefit of this source of finance is that when the company issues debentures it does not result in dilution of ownership as is the case with the issue of equity shares and therefore owners of company get funds without diluting the control of the company.
It also has the tax advantage because interest paid on debentures is a tax deductible expense and hence company gets the tax benefit which leads to more profits for the company because of lower tax payment.
No Voting Right
Since debenture holders do not have any voting rights they do not interfere with the working of the organization and hence does not create any obstacles in decision making process of the organization.
Fixed Rate of Interest
If the firm makes good profits during the year then unlike equity shares where you have to distribute that profit to the shareholders, debentures holders’ payment of interest is fixed and hence firm does not need to share profits with them.
Cons of Debentures
Payment of Interest is Mandatory
The biggest con of this source of finance is that payment of interest on debentures is mandatory and when company is making low profits or losses than these payments can lead to more strain on company’s balance sheet and nonpayment of interest can even lead to bankruptcy for the firm.
Another disadvantage is that debenture is considered as loans or borrowings and therefore the ability of the company to borrow further in case of need of funds reduces considerably.
Huge Fund Outlay on Maturity
Since on maturity they have to be repaid, company needs to plan properly and keep funds for the same because when they are repaid it involves substantial cash outflows and if company has not maintained enough funds it is a recipe for disaster.
Large Institutional Investors
Unlike equity shares which are bought even by small retail investors, debentures are bought by large institutional investors and hence at times it may prove to be costly and difficult source of finance for the company.
As one can see that debentures has pros as well as cons and hence any company before deciding whether to issue them or not must look at above points and introspect whether in the long term such issue is profitable for the company or not.