Question

Discuss the disadvantages of raising finance through debentures.

Answer 1

1. Permanent Burden of Interest: Interest on debentures has to be paid every year, irrespective of profits. During periods of depression, it becomes a heavy burden on the company's earnings.
2. Reduction in Credit Standing: The creditworthiness of a company that has issued a large amount of debentures is low. Borrowing from banks and financial institutions becomes difficult.
3. Charge on Assets: Debentures usually involve mortgages of fixed assets. A company cannot raise funds easily through debentures unless it has enough fixed assets. During periods of depression, the company may not be able to repay the amount. Debenture holders may attach the pledged assets, which may paralyze business.
4. Reduction in Dividend: During times of low earnings, very little profit might be left after payment of interest on debentures. The company may not be able to pay enough dividends, and the market value of its shares may go down.
5. No Voting Rights: Debenturehoders have no voting rights in the management of a company. Therefore, they remain at the mercy of the shareholders.