Merits:
- Because of the fixed interest on debentures, companies with stable income can secure higher returns on equity capital by trading on equity.
- The rate of interest is usually lower than the expected rate of return on share capital. This is because debenture holders do not bear any risk.
- Debentures do not carry any voting right. Hence management by promoters or existing directors remains unaffected.
Demerits:
- If the earnings of the company are uncertain or unpredictable, issue of debentures may pose serious problems for the company due to the fixed obligation to pay interest and repay the principal
- The company is liable to pay interest even if there is no profit.
There are several advantages of issuing equity shares to raise ownership capital. The rate of dividend on these shares depends on profits available and the discretion of directors. There is, therefore, no fixed burden on the company. The shareholders expect high rates of dividend in profitable years. But they also bear the risk associated with uncertainty of earnings of the company. Thus, risk capital is available by issuing these shares. Further, the amount raised by issue of equity shares can be used permanently. It is not required to be paid back so long as the company exists. Moreover, equity shares do not require mortgaging of the company's assets.
