Question

Explain the key legal and practical factors that are considered when public limited companies decide between Debentures and Shares as a mechanism to raise cash. Clearly state two advantages and two disadvantages for the company. Answer not to exceed 300 words.

Answer 1

Ans. Key legal and practical factors that are considered when public limited companies decide between Debentures and Shares as a mechanism to raise cash include :

- Debentures are form of loan instrument that bear fixed interest rate. They do not dilute ownership control of company. They are tax deductible i.e., they are allowed in income statement as a expense so they have advantage of corporate tax deduction. Debenture holders are to be paid in all cases i.e., even if company is incurring losses. They have priority over shareholder at the time of liquidation. They are a fixed burden for company.

- Share are issued to shareholders of company who are also known as owners of company. They have control over company. Dividend is paid to shareholders out of current profits or out of retained earnings. Dividend is not tax deductible. They are paid dividend only when company has profits, so they do not act as fixed burden for company. They are paid in last at time of liquidation.  

Two advantages for the company:

- Debentures provide interest rate deduction on fixed interest paid to debenture holders for tax purposes.

- Shares do not result in fixed burden on company as in case of debenture interest. Dividend is paid to shareholders only when company earns profits.

Two disadvantages for the company:

- Debentures result in fixed interest burden on companies which sometimes result in liquidation of companies when companies are incurring losses and are not able to pay fixed interest obligations.

- Shares dilute ownership of companies. Issuance of shares result in reduction of ownership of existing shareholders of company.