Typically, debentures are categorised based on factors like security, tenure, coupon rate, convertibility and registration. Irredeemable debentures are one of those debentures that are classified based on terms. With that being said, the following is a look at irredeemable debentures meaning in detail.
As per the irredeemable debenture definition, such debentures cannot be redeemed during the life-time of the issuing company. In other words, irredeemable debentures can be redeemed only at the dissolution of the issuing company.
They may also be redeemed on expiry or if the issuing company is willing to repay the borrowed amount. Nonetheless, such an occurrence is quite rare. Such debentures are also called – perpetual debentures or perpetual bonds as the issuing company does not offer an understanding for repaying the money borrowed through their issuance. Furthermore, they do not come with a fixed date of redemption at the time of being issued.
It must be noted that issuing companies are required to pay interest on the debt instruments as agreed beforehand. It is considered to be a cost-effective means of borrowings. Additionally, the issuers have the call option, and the date for the same is set at every 5 years from issuance. Such debentures come in handy to raise long-term capital and are mostly issued by large manufacturing firms or financial institutions.
Perpetual debentures come under the purview of Additional Tier 1 bonds and hence manifest features of quasi-equity. It suggests that in case of dissolution, investors with this debt instrument will receive payments towards the end but before equity investors.
Some other prominent features include –
It must be noted that HNI investors or retail investors can avail irredeemable debentures through the secondary market. Also, the price is mainly dependent on the current as well as the expected interest rate applicable to it.
These debentures serve as an agreement between a lender and a borrower. They also accompany a promise of the favourable rate of interest. In the event when a company becomes insolvent, these debentures ensure that the company’s lenders are repaid first.
Following is an example to understand how irredeemable debenture works –
A machinery manufacturer makes an irredeemable debenture agreement with a lender for a fixed amount. The manufacturer uses the borrowed sum as required and maintains a healthy cash flow.
Now, as per the agreement, the manufacturing company cannot sell its premise and high-end equipment without the consent of lenders or before repaying the borrowed sum.
In case of dissolution, only after the irredeemable debenture holder has been paid, the company can proceed to sell its premise or pay off other creditors.
These following are regarded to be the most significant advantages of irredeemable debentures for both investors and issuers.
A. For issuers
B. For investors
These are among the common drawbacks of perpetual debentures for both investors and issuers.
a) For issuers
b) For investors
|Parameters||Irredeemable debentures||Redeemable debentures|
|Definition||These are debentures that do not come with a maturity date. Typically, they have a lifecycle as long as the life of the company.||These debentures come with a fixed maturity date. On expiry, the principal amount is repaid to investors.|
|Repayment Tenure||Issuers are not entitled to pay off debt anytime soon and may only choose to do so in the event of dissolution of the company or while using the callback feature of callable debentures.||Issuers are required to pay-off their due on the expiry of the pre-fixed time frame. Issuers can repay either in a lump sum or in instalments either at par or premium.|
Despite these benefits, this debt instrument has some significant limitations as well. Both investors and issuers must weigh them to make the most of this investment proposition. Also, they must factor in their risk-taking capability and financial goals before investing in irredeemable debentures.