Unit 2
Capital of a Company
Share Capital – Meaning of Shares
Share capital denotes the amount of capital raised by the issue of shares, by a company. It is
collected through the issue of shares and remains with the company till its liquidation.
Share capital is owned capital of the company, since it is the money of the shareholder and
the shareholder are the owners of the company. The total share capital is divided into small
parts and each part is called a share. Share is the smallest part of the total capital of a
company.
Types of Shares
The capital of the company can be divided into different units with definite value called
shares. Holders of these shares are called shareholders or members of the company. There
are two types of shares which a company may issue (1) Preference Shares (2) Equality
Shares.
1. Preferences Shares: Shares which enjoy the preferential rights as to dividend and
repayment of capital in the event of winding up of the company over the equity
shares are called preference shares. The holder of preference shares will get a fixed
rate of dividend. Preference shares may be
a) Cumulative Preference Share: If the company does not earn adequate profit in any
year, dividends on preference shares may not be paid for that year. But if the
preference shares are cumulative such unpaid dividends on these shares go on
accumulating and become payable out of the profits of the company, in subsequent
years. Only after such arrears have been paid off, any dividend can be paid to the
holder of quality shares. Thus a cumulative preference shareholder is sure to receive
dividend on his shares for all the years out of the earnings of the company.
b) Non-cumulative Preference Shares: The holders of non-cumulative preference shares
no doubt will get a preferential right in getting a fixed dividend it is distributed to
quality shareholders. The fixed dividend is to be paid only out of the divisible profits
but if in a particular year there is no profit as to distribute it among the shareholders,
the non-cumulative preference shareholders, will not get any dividend for that year
and they cannot claim it in the next year during which period there might be profits.
If it is not paid, it cannot be carried forward. These shares will be treated on the
same footing as other preference shareholders as regards payment of capital in
concerned.
c) Redeemable Preference Shares: Capital raised by issuing shares, is not to be repaid
to the shareholders (except buy back of shares in certain conditions) but capital
raised through the issue of redeemable preference shares is to be paid back by the
raised thought the issue of redeemable preference shares is to be paid back to the
company to such shareholders after the expiry of a stipulated period, whether the
company is wound up or not. As per section (80) 5a, a company after the
commencement of the Companies (Amendment) Act, 1988 cannot issue any
preference shares which are irredeemable or redeemable after the expiry of a period
of 10 years from the date of its issue. It means a company can issue redeemable
preference share which are redeemable within 10 years from the date of their issue.
d) Participating or Non-participating Preference Shares: The preference shares which
are entitled to a share in the surplus profit of the company in addition to the fixed
rate of preference dividend are known as participating preference shares. After the
payment of the dividend a part of surplus is distributed as dividend among the
quality shareholders at a particulate rate. The balance may be shared both by equity
shareholders at a particular rate. The balance may be shared both by equity and
participating preference shares. Thus participating preference shareholders obtain
return on their capital in two forms (i) fixed dividend (ii) share in excess of profits.
Those preference shares which do not carry the right of share in excess profits are
known as non-participating preference shares.
2. Equity Shares: Equity shares will get dividend and repayment of capital after meeting
the claims of preference shareholders. There will be no fixed rate of dividend to be
paid to the equity shareholders and this rate may vary form year to year. This rate of
dividend is determined by directors and in case of larger profits, it may even be more
than the rate attached to preference shares. Such shareholders may go without any
dividend if no profit is made.
Difference between Equity and Preference Shares
Equity Shares
Preference Shares
Equity shares are those shares that do not Preference shares are those shares which
enjoy any preference as regards payment of enjoy preference as regards payment of
dividend and repayment of capital
dividend and repayment of capital
The rate of dividend is not fixed. It depends The rate of dividend on preference shares is
on the profits made by a company i.e. higher fixed
the profits, higher the dividend, lower the
profits, lower the dividend.
Equity shareholders are paid their capital Preference shareholders are paid their
after the preference shareholders are paid.
capital first
They have normal voting rights.
Preference shareholders do not have normal
voting rights
Equity shares have no classification.
Preference shares are classified into many
types like cumulative preference shares,
non-cumulative,
convertible
preference
shares, non-convertible preference shares,
participating
preference
shares,
non-
participating preference shares, redeemable
preference
shares
and
irredeemable
preference shares.
Equity shares receive dividend after it is paid These shareholders receives dividend first.
to preference shares
Debentures – Meaning
A Debenture is a debt security issued by a company (called the Issuer), which offers to pay
interest in lieu of the money borrowed for a certain period. In essence it represents a loan
taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument
and repays the principal normally, unless otherwise agreed, on maturity.
These are long-term debt instruments issued by private sector companies. These are issued
in denominations as low as Rs 1000 and have maturities ranging between one and ten years.
Long maturity debentures are rarely issued, as investors are not comfortable with such
maturities
Features of Debentures
1. Debenture holders are not the owners of the company. They are considered the
creditors of the corporation or in other words, the company borrow money from
them through issuing debenture.
2. No voting rights. The debenture-holder is not a shareholder and cannot vote in the
company's general meetings.
3. Fixed rate of interest. A debenture with a fixed charge has a fixed rate of interest. It
can be presented as "10% Debenture". They are always unsecured and earns a fixed
rate of interest but has no share of the profit.
4. Compulsory payment of interest. The interest on debenture is payable irrespective
of whether there are profits made or not.
5. Redeemable and Irredeemable. A redeemable debenture is the one which is to be
repaid within a maturity period, while Irredeemable or Non-redeemable debentures
cannot be redeemed in the life time of the company and only repayable upon the
liquidation of the corporation.
Types of Debentures
Security
 Secured/Mortgage Debentures: Debentures secured against assets of the company
.i.e. if the company is winding up, assets will be sold and debent
 ure holders will be paid back. The charge/mortgage may be fixed or a floating
charge. If it is fixed, charge is on a specific asset say plant, machinery etc. If it is
floating charge, it means it is on general assets of the company.
 Which assets are charged: The ones available with the company presently and also
assets in future
 Mortgage deed: Includes nature/value of the security, date of interest payment, and
rate of interest, repayment terms, and rights of the debenture holders if the
company defaults. In the event of default of company to pay interest or principal
installment, they can recover their money via the assets mortgaged.
 Unsecured/Naked Debentures: Debentures not secured against assets of the
company .i.e. if the company is winding up, assets will be not be sold in order to pay
the debenture holders. In other words, no charge is created on the assets of the
company which means that there is no security of interest and principal payment.
The creditworthiness and soundness of the company serves as a security.
Tenure
 Redeemable Debentures: Debentures which have to be repaid within a certain
specified period. Eg: 5% 2 years Rs. 1000 debenture means redeemable period is 2
years(5%:interest/coupon payment). After redemption, they can be reissued.
 Irredeemable/Perpetual Debentures: These can be paid back at any time during the
life of the company .i.e. there is no specified period for redemption. Hence they are
also called Perpetual Debentures. Nonetheless if the company has to wind up, then
they have to repay the debenture holders.
Registration
 Registered Debentures: As the name suggested, these are debentures that are
registered with the company. It records all details of debenture holdings such as
name, address, particulars of holding etc. Interest shall be paid only to the registered
holder (treated as a non-negotiable instrument). They can be transferred by a
transfer deed.
 Bearer Debentures: These can be transferred by mere delivery. Company does not
hold records for the debenture holder. Interest will be paid to the one who displays
the interest coupon attached to the debenture.
Coupon
 Zero Coupon Debentures: Does not have a specified interest rate, thereby to
compensate, they are issued at a substantial discount. Interest: Difference in face
value and issue price.
 Specific Coupon rate Debentures: Debentures are normally issued with an interest
rate which is nothing but the coupon rate. It can be fixed or floating. Floating is
associated with the bank rates.
Convertibility
 Convertible Debentures (Fully/ Partly convertible): Debentures which can be
converted to either equity shares or preference shares by the company or debenture
holders at a specified rate after a certain period. A company can also issue Partly
Convertible Debentures whereby only a part of the amount can be converted to
equity/preference shares.
 Non Convertible Debentures (NCDs): These can’t be converted into
equity/preference shares.
Advantages/Merits of Debentures
a) It enables a company to raise funds for a specific period.
b) No dilution of control as debenture holders don’t possess voting rights
c) Debenture (debt) enables the company to Trade on equity. It can pay dividend to
equity shareholders at a rate higher than overall ROI.
d) Debenture holders entitled to a fixed rate of interest. Eg: 10% debenture
e) They enjoy priority over other unsecured creditors with respect to debt repayment.
f) Suitable for conservative investors who seek steady ROI with little or no risk.
g) Interest on debentures is treated as expense and is tax deductible.
h) Company can adjust its gearing in accordance to its financial plan.
i) Debenture holders are regarded as creditors of the company and they receive
preference over equity shareholders and preference share holders.
Disadvantages/Demerits of Debentures
a) They have a fixed maturity; hence provision has to be made for repayment.
b) There is a limit to which funds can be raised through debentures.
c) It is risky if the company fails to pay interest or principal installment on time, as
debenture holders can file petition for winding up the company.
d) It is not suitable for a company with fluctuating earnings as it may also lead to
fluctuations in payment of dividend payable to equity shareholders.
e) With more risk, you get more return. Debentures being secure investments, returns
are less.
f) Like ordinary shares, debenture holders will not be regarded as owners of the
company and have no voting rights.
SEBI Guidelines for Equity Issue
1) Eligibility of Issuer: The company shall meet the following requirements –
 Net Tangible Assets ≥ ` 3 crores (for 3 full years)
 Should have track record of profitability in 3 out of previous years
 Net worth ≥ ` 1 crore in three years
 If change in name, at least 50% revenue for preceding 1 year should be from the
activity under new name
2) Size of the Public Issue:
 Issue of shares to public ≥ 25% of the total issue,
 The issue size should not be more that five
times the pre-issue net wort
3) Promoter Contribution:
 Minimum Promoters contribution is 20-25% of the public issue.
 Minimum Lock in period for promoters contribution is 5 years
4) Prospectus:
 Abridged prospectus must be attached with every application form.
 Risk factors must be highlighted
 Objectives of the issue and the cost of the project should be disclosed
 Company’s management, past history and present
 business of the firm should be disclosed
 Particulars of the company and other listed companies under the same
management who have made public issues during the past 3 years are to be
disclosed
5) IPO Grading:
 A company which has filed the draft offer document for its IPO with SEBI is
required to obtain a grade from at least one CRA registered with SEBI like CARE,
ICRA, CRISIL and FITCH Ratings.
 A company can appeal once if it is not satisfied with the rating it has been given.
However, it can assign a the task of IPO grading to more than one credit rating
company and choose the best rating.
 IPO grades indicate how strong the company is with its fundamentals.
6) Timeframes for the Issue and Post- Issue formalities:
 The min. period = 3 working days and the max. = 10 working days.
 In case of over-subscription the company may have the right to retain the excess
application money and allot shares more than the proposed issue, which is
referred to as the ‘green-shoe’ option.
7) Dispatch of Refund Orders:
 Refund orders have to be dispatched within 30 days of the closure of the Public
Issue.
8) Other regulations pertaining to IPO:
 Underwriting is not mandatory but 90% subscription is mandatory for each issue
of capital to public except in disinvestment.
 If the issue is undersubscribed then the collected amount should be returned
back (not valid for disinvestment issues).
 If the issue size is more than ` 500 Crores , voluntary disclosures should be made
regarding the deployment of the funds and an adequate monitoring mechanism
to be put in place to ensure compliance.
 Code of advertisement specified by SEBI should be adhered to.
SEBI Guidelines for Debenture Issue
a) Appointment and Duties of Debenture Trustees
In terms of Section 117 B, it has been made mandatory for any company making a
public/rights issue of debentures to appoint one or more debenture trustees before
issuing the prospectus or letter of offer and to obtain their consent which shall be
mentioned in the offer document. The Debenture Trustees shall not:
I.
Beneficially hold shares in a company.
II.
Beneficially entitled to monies which are to be paid by the company to the
debenture trustees.
III.
Enter into any guarantee in respect of principal debt secured by the
debentures or interest thereon.
This section also lists the functions that shall be performed by the Trustees. These
include:
I.
Protecting the interests of the debenture holders by addressing their
grievances.
II.
Ensuring that the assets of the company issuing debentures are sufficient to
discharge the principal amount.
III.
To ensure that the offer document does not contain any clause this is
inconsistent with the terms of the debentures or the Trust Deed.
IV.
To ensure that the company does not commit any breach of the provisions of
the Trust Deed.
V.
To take reasonable steps as may be necessary to undertake remedy in the
event of breach of any covenant in the Trust Deed.
VI.
To convene a meeting of the debenture holders as and when required.
If the debenture trustees are of the opinion that the assets of the company are
insufficient to discharge the principal amount, they shall file a petition before the
Central Government and the latter may after hearing the parties pass such orders as
is necessary in the interests of the debenture holders. As per the SEBI (Debenture
Trustees) Regulations, 1993, {hereinafter referred to as the 'Regulations'} a
Debenture Trustee can be a scheduled bank, an insurance company, a body
corporate or a public financial institution.
b) Debenture Trust Deed: A Debenture Trust Deed shall, interalia, include the following:
I.
An undertaking by the company to pay the Debenture holders, principal and
interest.
II.
Clauses giving the Trustees the legal mortgages over the company's freehold
and leasehold property.
III.
Clauses that may make the security enforceable in the event of default in
payment of principal or interest i.e. appointment of receiver, foreclosure,
sale of assets etc.
IV.
A clause giving the Trustees the power to take possession of the property
charged when security becomes enforceable.
V.
Register of Debenture holders, meeting of all debenture holders and other
administrative matters may be included in the Deed.
In addition thereto, the SEBI regulations have laid format of the Trust Deed in
Schedule IV to the regulations. Some of the important provisions would include
I.
Time limit of creation of security for issue of debentures.
II.
Obligations of the body corporate towards the debenture holders.
III.
Obligations towards the debenture holders - equity ratio and debt service
coverage ratio.
IV.
Procedure for the inspection of charged assets by the Trustees.
c) Creation of debenture Redemption Reserve: Section 117 C of the Act casts an
obligation on the company to create a Debenture Redemption Reserve. This account
will be credited with proceeds from the profits of the company arrived at every year
till redemption of the debentures. The Act, however, does not stipulate the time
period for creation of security. SEBI regulations provides for creation of security
within six months from the date of issue of debentures and if a company fails to
create the security within 12 months, it shall be liable to pay 2% penal interest to the
debenture holders. If the security is not created even after 18 months, a meeting of
the debenture holders will have to be called to explain the reasons thereof. Further,
the issue proceeds will be kept in escrow account until the documents for creation of
securities are executed between the Trustees and the company.
d) Default: In the event of failure on the part of the company to redeem the
debentures on the date of maturity, the Company Law Tribunal may, on the
application of any debenture holder, direct redemption of debentures forthwith by
payment of principal and interest due thereon. If a default is made in complying with
the orders of the Tribunal, every officer of the company who is in default shall be
punishable with imprisonment for a term which may extend to three years and shall
also be liable to fine of not less than Rs.500/- for every day during which the default
continues. (Section 117C) Further this offence is not compoundable under section
621A of the Act.
There are contradictions between the Companies Act and the SEBI regulations on
issues relating to:
I.
Utilisation of Debenture Redemption Reserves. The Act provides that the
Debenture Redemption Reserve will be used towards redemption of
debentures only whereas the SEBI regulation states that these will be a part
of the General Reserves, which can be utilised for the purpose of bonus
issues.
II.
Any debentures issued with a maturity period of 18 months or less is
exempted from the creation of Debenture Redemption Reserve Account,
whereas no such exemption is provided under the Companies Act.
III.
No Public Issue/Rights Issue of Debentures shall be made by a company
unless it has appointed one or more Debenture Trustees for such debentures
whereas under SEBI guidelines, appointment of Debenture Trustees is
compulsory only in case of debentures with maturity of 18 months or more.