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.

What is Irredeemable Debenture?

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.

Features of Irredeemable Debenture

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 –

  • Maturity date – Like discussed, perpetual bonds do not come with any maturity date. Nonetheless, issuers have the right to callback callable debentures.
  • Coupon interest – Investors are entitled to receive interest on these bonds. Notably, the amount of payout depends on the issuing company’s profitability in the current year.
  • Risk level – Irredeemable debentures come with high liquidity risk and a low to moderate credit risk. In addition to these, the debt instrument is also exposed to moderate interest rate risk.
  • Investment value – The minimum investment value against this debt instrument is Rs.10 lakh. On the other hand, the maximum investment value can be as much as Rs.50 lakh or more.

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.

How do Irredeemable Debentures Work?

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.

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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.

Advantages of Irredeemable Debentures 

These following are regarded to be the most significant advantages of irredeemable debentures for both investors and issuers.

A. For issuers 

  • They enable issuers to save on the cost of issuing or refinancing in the long-term.
  • Irredeemable debentures help to raise large capital requirements and in turn allow grasping bigger projects with a lengthy time-frame.
  • They are adept at avoiding capital market risks.
  • The callable features allow holders to redeem their bonds at additional advantages under favourable economic conditions or interest rates.

B. For investors

  • The interest on debentures serves as a source of steady and regular income for investors.
  • Investors are also guaranteed to receive payment in case of dissolution or liquidation.
  • These debentures save them from the hassle of reinvesting.

Disadvantages of Irredeemable Debentures 

These are among the common drawbacks of perpetual debentures for both investors and issuers.

a) For issuers

  • Even though it is a one-time issuance, issuers have to pay interest until redemption.
  • Perpetual debentures do not follow a very favourable and optimised capital structure.

b) For investors

  • Their funds stay blocked for a long time. This prevents them from investing in other lucrative investment options.
  • Issuers can take advantage of the call back feature of callable debenture and repurchase, resulting in zero to negligible profits for investors.
  • Investors are exposed to insolvency risks owing to an indefinite time frame and risks similar to that of equity holders.

Differences between Irredeemable and Redeemable Debentures 

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.