Debenture can be redeemed in various ways by a company. It can pay a lump sum on the date of maturity or may pay in annual installments. A company can also purchase it from the open market or convert it to an equity share in case of convertible debentures. Innovative ways like the call or put option can also be utilized. The company may exercise a call option, or the investor may use the put option for redemption.
Redeeming a debenture means paying back the principal amount to the debenture holder. Redemption is a basic feature of debentures. To speak in the company’s language, discharge off the debt liability of debentures. Debenture redemption generates questions in mind with specifications like the amount of money required, sources from where to manage the fund, etc. After this, a company is also relieved of a big liability and decreases its leverage ratios. Let us see more about the redemption of debentures.
Redemption of Debenture
There are various ways for redemption debentures which are discussed:
Lump-Sum Payment on a Fixed Date
This is the simplest option for redeeming the debentures. The debenture holders are paid their promised sum on the fixed date.
The lump sum is the total amount of principal of all the debentures if they are not redeemed at a premium or discount. The fixed date is nothing but the maturity date mentioned on the debenture agreement. The company may choose to pay the debentures before maturity also, which is the option of the company. The amount of payment and the date is known to the company in advance, and therefore, they can manage the resources accordingly.
Payment in Annual Installment
This kind of redemption is similar to the redemption of a term loan. A term loan is normally redeemed monthly, quarterly, biannual, or annual installments. In this method, the company pays some part of the principal every year to the debenture holders until maturity. The total principal is divided by the number of years for which they are borrowed, which becomes the installment to be paid at the end of every year.
Debenture Redemption Reserve / Sinking Fund
Debenture redemption reserve is a very well-known term for debentures. This reserve is built by transferring some part of the profits in this reserve every year. It is always easy to arrange smaller funds every year than arranging a lot of funds at a particular point in time for payment to debenture holders. Law has made it compulsory to maintain a debenture redemption reserve or a sinking fund in many countries. The primary objective is to protect the interest of the debenture holders.
Buy from Open Market
If the debentures are traded on a regulated exchange, the company can opt to purchase them from the open market. It will reduce a lot of administrative paperwork and efforts of manpower.
Conversion into Shares
There is a type of debentures called convertible debentures, which contain a clause of conversion into ordinary equity shares of the company. As per the agreed terms and time period, the convertible debenture is converted into a common equity share. And at that point of conversion, the debenture liability is discharged.
Call and Put Option
A company may issue a debenture with the call option or put option for the redemption purpose. A call option is exercised by the company whereby it can opt to purchase the debentures on or before the date of maturity at a price that is arrived at according to the terms and conditions mentioned at the time of issue. Similarly, a put option is exercised by the debenture holder. He has the right to sell the debenture to the company at some agreed price on or before the maturity date. It is an innovative way of redeeming the debentures. As is the case for investors, a call option gives the company the freedom to get away from the burden when it wishes to do so and vice versa.