2. Preference and Equity Capital
Preference Capital
Definition: The Preference Capital is that portion of capital which
is raised through the issue of the preference shares. This is the
hybrid form of financing that has certain characteristics of equity
and certain attributes of debentures.
3. Advantages of Preference Capital
• There is no legal obligation on the firm to pay a dividend to the
preference shareholders.
• The redemption of preference shares is not distressful for a firm
since the shares are redeemed out of the profits and through the
issue of fresh shares (preference shares and equity shares).
• The preference capital is considered as a component of net worth
and hence the creditworthiness of the firm increases.
• Preference shareholders do not enjoy the voting rights, and thus,
there is no dilution of control.
4. Disadvantages of Preference Capital
• It is very expensive as compared to the debt-capital because unlike debt
interest, preference dividend is not tax deductible.
• Although, there is no legal obligation to pay the preference dividends,
when the payment is made it is done along with the arrears.
• The preference shareholder can claim prior to the equity shareholders,
in case the dividends are being paid or at the time of winding up of the
firm.
• If the company does not pay or skips the preference dividend for some
time, then the preference shareholders could acquire the voting rights.
5. Equity Capital
• The Equity Capital refers to that portion of the organization's
capital, which is raised in exchange for the share of ownership
in the company. These shares are called the equity shares. The
equity shareholders are the owners of the company who have
significant control over its management.
6. Advantages of equity finance
• The firm has no obligation to redeem the equity shares since these
have no maturity date.
• The equity capital act as a cushion for the lenders, as with more
and more equity base, the company can easily raise additional
funds on favorable terms. Thus, it increases the creditworthiness
of the company.
• The firm is not bound to pay dividends, in case there is a cash
deficit. The firm can skip the equity dividends without any legal
consequences.
7. Disadvantages of equity finance
• here are several disadvantages of raising the finances through the issue of equity shares which are
listed below:
• With the more issue of equity shares, the ownership gets diluted along with the control over the
management of the company.
• The cost of equity capital is high since the equity shareholders expect a higher rate of return as
compared to other investors.
• The cost of issuing equity shares is usually costlier than the issue of other types of securities. Such
as underwriting commission, brokerage cost, etc. are high for the equity shares.
• The cost of equity is relatively more, since the dividends are paid out of profit after tax, but the
interest payments are tax-deductible.
8. Debenture and Bond
• Meaning of Debenture:
It is the type of loan or debt instrument which is issued in the
market to subscribe to the public. It is not taken from any individual
institution. It is issued like equity or preference shares in the
market for purchase and sale to the number of subscribers. Like
every type of loan, it also has a fixed rate of interest which will be
paid by the company to the subscriber after some fixed period of
time. The subscriber of it is known as the Debentureholder.
Debentureholder will be paid from the preference and equity
shareholders in the situation of liquidation of the company.
9. • Definition of Debenture:
“Debenture includes debentured stock, bonds, and any other
instrument of the company evidencing a debt, whether constituting
a charge on the assets of the company or not.”
– Section 2(30) of the Companies Act, 2013
“A debenture is a document given by a company as evidence of a
debt to the holder usually arising out of a loan and most commonly
secured by a charge.” -Topham
10. Types of Debentures:
• The types of debentures are can be categories on the basis of:
• Security
• Redemption
• Convertibility
• Registration
11. On the Basis of Security: –
The types of Debentures which are categorized on the basis of Security can be
divided into two subcategories. These are shown as below:
1. Secured:
Secured Debentures are those which are secured against the fixed
asset. That means if the business suffering from loss and about to short down then
the specific asset which these are secured the amount realized from that asset
will be paid to the secured debenture holders.
2. Unsecured:
Unsecured Debentures are those which are not secured against the fixed
assets. That means if the business suffering from loss and about to short down
then these types of debenture holder will get the amount in proportionate which
is realized from the total assets for the business.
12. On the Basis of Redemption: –
The types of Debentures which are categorized on the basis of
Redemption can be divided into two subcategories. These are shown
as below:
1. Redeemable: Redeemable Debentures are those which are
redeemed after the fixed maturity date.
2. Irredeemable: Irredeemable Debentures are those which are not
redeemed after the fixed maturity date.