Article explains Meaning and Nature of Debentures and Preference shares . It further explains Status of Debenture / Preference share Holders, Obligation to Company of Debenture / Preference share Holders and further explains Share of Profits, Tax Benefit, Cheaper source of Finance, Effect on Authorized capital and Blockage of funds in increasing authorized capital.
| S.No | Point of Difference | Debentures | Preference shares |
|---|---|---|---|
| 1. | Meaning | The debentures are the borrowed funds of the company. | Preference shares are the Capital funds of the company. |
| 2. | Nature | These are debt financing instrument hence represents debt of the company | These are capital financing instrument with preferential ownership rights hence represents capital of the company |
| 3. | Status of Holders | Creditors | Owners |
| 4. | Obligation to Company | Interest has to be paid annually irrespective of profits earned by the company | Preference dividend has to be paid only out of the profits earned by the company |
| 5. | Dilution of Control | Issuing of debentures does not dilute the control of existing shareholders | Issuing of preference shares indirectly dilute the control of existing shareholders |
| 6. | Share of Profits | No dilution in profit sharing percentage of existing shareholders | Dilution in profit sharing percentage of existing shareholders |
| 7. | Tax Benefit | Debenture financing results in interest expense for the company, which is tax deductible expense | Preference shares financing results in dividend expense for the company which is not a tax-deductible expense |
| 8. | Cheaper source of Finance | The interest cost incurred on debentures has tax shield which indirectly lowers the cost | No tax benefit is availed on preference capital |
| 9. | Effect on Authorized capital | As debentures are debt financing instruments, it has no effect on Authorised capital of the company | As preference shares are capital financing instrument it has an effect on Authorized capital of the company |
| 10. | Blockage of funds in increasing authorized capital | No blockage of fund as there is no requirement of increasing Authorized capital and no payment of stamp duty | Blockage of funds as the company is required to its increase the authorized capital for issuing preference capital |
Conclusion:
On the basis of above it is advisable to bring in additional funds in the form of debentures as debt financing has major advantages such as tax benefit, lower cost and no dilution of control.
Author: Ranjana is an Associate at M&K Associates and can be reached at [email protected]
Disclaimer: The views, information or opinions expressed herein are compiled by the Legal team of M&K Associates, Company Secretaries, Hyderabad. The above information is solely for disseminating knowledge and private circulation. We are hereby not liable for any loss, damage or inconvenience caused as a result of reliance on such information and we accept no legal liability or other responsibility by or on behalf of any errors, omissions, or statements on this content.
