Raising Capital through Debentures: Guide for Private Limited Companies

Applicable sections:  Section 23 – Public and Private Offer of Securities

• Section 42 – Private Placement
• Section 62 (1) (c) – Preferential issue of Convertible Debentures
• Section 71 – Issuance of Debentures
• Section 73, 77 and 78 – Issuance of Deposits and registration of Charges
• Section 88 – Register of member

Applicable Rules:

• Rule 14 of Companies (Prospectus and allotment of securities) Rules, 2014;
• Rule 13 of Companies (Share Capital and Debentures) Rules, 2014;
• Rule 18 of companies (Share Capital and Debentures) Rules, 2014;
• Rules 3 Companies (Registration of charges) Rules, 2014.

Private Limited often faces challenges when it comes to funding raising process primarily due to prohibition on access  to public resources and will rely on the  private placements, institutional buyer and traditional bank loan – the latter  being a time consuming process; needs collateral and subject to bank lending policy.

In this context, the issuance of debentures has become an increasingly attractive option for Private Limited Companies. Debentures serve as a flexible and effective fundraising instrument, allowing companies to raise debt capital without diluting ownership. Debenture as defined in the section 2(30) of the companies act, 2013 “includes bond, debenture stock or any other instrument of the company evidencing a debt whether constituting a charge on the asset of the company or not”. A debenture is essentially a form of loan taken by the company from debentures holders with a promise of repayment of principal amount along with the fixed rate of interest at predetermined regular intervals to the holders of the instrument whether secured against the assets of the company or not. Also a good investment avenue for the holders with steady return fixed interest and principal payment at the end of the term.

A Private Limited Company can raise funds by issuing debentures through private placement to a limited number of investors (not exceeding 200 persons in a financial year excluding the QIBs and employees of the company securities offered under the scheme of ESOP).

The Company can also issue convertible Debentures by way of preferential issue under section 62(1) (c) but it is not allowed to raise funds directly from the public.

Even when convertible debentures are issued under preferential allotment, the provisions of Section 42 (private placement) apply, as preferential allotment is a form of private placement. Therefore, it is important to comply with both Section 42 and Section 62(1) (c), along with other relevant provisions governing debentures, to ensure full legal and procedural compliance.

Types of Debentures:

On the basis of security:

Secured Debentures:  These debentures are secured by the creation of charge against the any properties and assets referred to in Schedule III of the Companies Act, 2013 excluding intangible assets of the company or its subsidiary or its holding companies or its associate companies which will be sufficient for the due repayment of the amount of debenture and interest thereon.

Unsecured Debentures: These debentures are not secured by way of creation of charges against the properties and assets of the company also called as naked Debentures. As the result interest rate provided for these debentures are high when compared to secured debentures.

On the basis of transferability:

Bearer Debentures: These debentures are payable to the Bearer of the instrument and easily transferable by mere delivery. This is also called as unregistered Debentures.

Registered Debentures: These debentures are not transferred by mere delivery and shall be transferable as per the provisions of the Companies Act 2013 by executing transfer deed. A registered holder of a debenture means a person whose name appears both in the debenture certificate and in the register of debenture holders. Principal and interest amount, when due in respect of these debentures are payable to the registered holders thereof only.

On the basis of repayment:

Redeemable debenture: These debentures are repayable at the end of the term of the instrument. Rule 18 applies only to secured debentures. For unsecured debentures, general terms of the issue applies The company may redeem debentures, either wholly or partly, at par or at a premium, in accordance with the terms of issue.

Irredeemable debentures: These debentures do not have a fixed maturity period, and the company is not obligated to repay the principal amount unless it is choosing to do so.  However such instruments are prohibited under Companies act 2013. There is no provision for irredeemable debentures under Companies Act, 2013; all the debentures issued under the act shall be redeemed within a specific period.

On the basis of conversion:

Convertible debentures:  These debentures, at the end of the term, will be converted into equity shares of the company. Thus the debenture holders will become equity shareholders of the company. Such Conversion, whether wholly or partly shall be approved by special resolution by the shareholders. Valuation report is necessary for issuing Convertible debentures.

Non Convertible debentures (NCD): These debentures do not have the option of being converting into equity share at the end of the term.

Note:  If the company wishes to issue unsecured NCD, it shall be mandatory for listing of the securities on the recognized stock exchange so that same does not come under the purview of deposits. (Rule 2 (1) (c) of Companies (Acceptance of Deposits), Rules, 2014.

Mandatory requirements under Section 71 of Companies Act, 2013 (For Every Kind Debenture):

1. Voting Right:

Debentures shall not carry any voting rights.

2. Debenture Redemption Reserve (DRR) account:

Where the Debenture is issued under the Act, DRR account shall be created out of the profits available for the payment of dividend. The amount in the reserve must be utilized by the company only for the purpose of redeeming of debentures. As per the rule 18 of the of the Companies (Share Capital and Debentures) Rules, 2014, there are certain exemption apply to specific classes of companies. For the Private Limited Company (other than NBFCs and housing finance Company) minimum DRR to be maintained is 10% of the value of the outstanding debentures.

3. Interest and Redemption of Debenture:

Payment of Interest and redemption of debenture shall be in accordance with the terms and conditions specified at the time of issue.

4. Default:

If case of any default in payment of interest or failure to redeem debentures at the end of the term, any or all debenture holders or by debenture trustee, may file an application before the National Company Law Tribunal (NCLT). The tribunal after hearing the parties concerned may order the company to redeem the debentures forthwith.

Mandatory Requirement for secured Debentures as per Rule 18, Companies (Share Capital and Debentures) Rules, 2014. 

1. Redemption Period:

Secured Debentures may be issued having redemption period not exceeding 10 years. Some kind of company (i.e Companies involved in Infrastructure Projects) may issue Secured debentures having redemption period exceeding 10 years but not exceeding 30 years.

2. Creation of Charge:

As explained earlier Secured Debentures are secured by the creation of charge on the properties and asset referred to in Schedule III of the Companies Act, 2013 excluding intangible assets of the company or its subsidiary or its holding companies or its associate companies which will be sufficient for the due repayment of the amount of debenture and interest thereon.  Creation of charge shall be made in the favor of the Debenture trustee.

3. Appointment of Debenture Trustee:

While the appointment of a Debenture Trustee is not mandatory unless the offer is made to more than 500 persons, it become mandatory in the case of secured debentures, as Form CHG-9 (filed for the purpose of creation of charge for Debentures) requires the mention of at least one Debenture Trustee for filing.

It is still advisable to appoint a Debenture Trustee even in the case of unsecured debentures, for better investor protection and compliance.

Process involved in the Issue of Debentures:

1. Board Meeting:

Conduct Board meeting for approving list of identified buyers, draft offer letter, issue of debentures, appointment of Debenture trustee and to fix the day, date and time of the annual general meeting.

2. Shareholders’ approval:

Conduct EGM for getting shareholder approval of offer document as recommended by the Board and issue of debentures on preferential issue through private placement.   File FORM MGT 14 within 30 days of passing the special resolution.

3. Valuation report:

Obtain Valuation report from the registered valuer is required in case of convertible debentures to be issued. (Note: In case of Non-Convertible Debenture, there is no dilution of share-holding in the share capital of the company, valuation of securities and justification of price are not applicable.) 

4. Offer letter:

The offer letter in Form PAS-4 shall be issued only to the identified persons as approved by the Board. The company must maintain a complete record of such private placement offers in Form PAS-5. The offer can be subscribed only by the persons to whom the offer is made, and not by any third party. The application money shall be received only through cheque, demand draft, or other banking channels, and payment in cash is strictly prohibited under Section 42 of the Companies Act, 2013. The company must also maintain a record of the bank account from which such subscription amounts are received to ensure traceability and compliance.

5. Allotment of Debentures:

Allotment of Debentures should be done with 60 days from the receipt of the application money. Convene Board meeting for approving allotment of debentures. File FORM PAS 3 for return of allotment of debentures within 15 days of allotment.

6. Execution of SH 12:

If appointment of debenture trustee is applicable then the Company should execute trust deed in the FORM SH 12 or any format nearer to that in the favor of Debenture trustees within three months of closure of the issue or offer and before the filing of FORM CHG 9.

7. Creation of Charge (In case of Secured Debentures):

Creation of charge against the any properties and excluding intangible assets of the company or its subsidiary or its holding companies or its associate companies in favor of debenture trustee in FORM CHG 9 within 30 days of allotment of Debentures along with the instrument of Charge and details of Trustees. 

8. Issue of Debenture certificate and maintain register:

Issue debenture certificates to allottees within 6 months from the date of allotment. Maintain a Register of Debenture Holders under Section 88 .Also maintains necessary records of private placement offers and acceptances.

FEMA regulations to be covered under various scenarios of issue of Debentures:

When Company is Issuing Secured Non Convertible Debentures (NCD):

1.Only listed Secured NCDs are permissible for subscription by foreign investors under the FEMA (Debt Instruments) Regulations, 2019.

2. These can be issued on a repatriation or non-repatriation basis.

3. Since they are not convertible into equity shares, Form FCGPR is not applicable.

4. Secured NCDs are classified as debt Instruments, and if they meet the criteria under the External Commercial Borrowing (ECB) framework, reporting must be done under the ECB guidelines. Accordingly, applicable ECB regulations must be followed, including:

• • Reporting through Form ECB at the time of drawdown.

• • Monthly filing of ECB-2 returns with the RBI.

When Company is Issuing Compulsory Convertible debentures (CCD):

1. CCDs will be governed by FEMA (Non Debt Instruments) Regulations, 2019, as they are convertible into equity.

2. A NRI or an OCI may, on non-repatriation basis, may subscribe to CCDs of an Indian company subject to sectoral caps and pricing guidelines.

3. It will be treated as FDI and when converted it will affect the capital structure of the company, hence FORM FCGPR has to be filed within 30 days of allotment of CCDs.

4. The valuation of CCDs shall be done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India or a practicing Cost Accountant, in case of an unlisted Indian Company.

(Explanation: In case of convertible equity instruments, the price or conversion formula of the instrument should be determined upfront at the time of issue of the instrument. The price at the time of conversion should not in any case be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with these rules)

When Company is issuing Optionally Convertible Debentures (OCD):

1. These debentures will be treated as the Debt and not as the FDI until conversion.

2. If they meet the criteria as a debt under ECB, reporting must be done under the ECB guidelines. Accordingly, reporting through Form ECB and the monthly ECB-2 return is required to be filed.

3. Upon conversion into equity, the instrument becomes FDI and the company must file Form FC-GPR within 30 days.

When the company is issuing Unsecured Non-Convertible Debentures:

1. To qualify under the ECB framework, debentures must be secured — typically by immovable property, movable assets, or financial securities.

2. FEMA does not permit foreign investment in unsecured NCDs, as they fail to meet the security criteria required under ECB guidelines.

3. Accordingly, Indian companies are not permitted to issue unsecured NCDs to foreign investors under FEMA, and such instruments cannot qualify as ECB.

 Summary of FEMA Compliance:

Conclusion:

The issuance of debentures offers a viable and strategically flexible fundraising route for Private Limited Companies in India. With restrictions on public funding and the challenges involved in bank financing, debentures—whether secured, unsecured, convertible, or non-convertible—can provide a much-needed avenue for raising capital without diluting ownership.

Companies must ensure careful planning, legal due diligence, and robust documentation to successfully structure and execute a debenture issuance. In summary, while the debenture route is powerful, it is equally governed by a well-laid statutory framework that requires precise and proactive execution.