The Telegram

Through this story, you are introduced to Preference and Debenture Capitals, along with other related terms

A few months later, while Soma was struggling to keep up with his expanding business, he got a telegram asking him to visit his village immediately. He got worried and started conjuring up various reasons for the invite; was someone ill? did his father want his money and the interest since the crops had failed? He rushed home by the earliest bus available. His mind was still cooking up worst case scenarios.

Instead of the long faces he was expecting, Soma was pleasantly surprised to be greeted by hugs from his extremely happy looking parents. After a good meal and some sweets, he was told that they had arranged his marriage to Gomti. Gomti and Soma’s families knew each other well, since they belonged to the same village, comprising a closely knit community. The girl’s father was a rich farmer with huge ancestral properties, while her brothers were doing good businesses in the city.

On meeting her parents, he discussed at length with them and his would-be father-in-law, why his magic tea formula wasn’t working any more. His  would-be father-in-law quickly understood the problem and offered Soma Rs.1000 to expand his business.

Soma's Rs 1000 to extend his business

The money was not to be treated as debt or partnership, he clarified; If Soma makes profits, he should pay his father-in-law 12% p.a. In case of no profits, the payment could be deferred, however, he should repay cumulatively @ 12%p.a. on the amount given by his father-in-law, whenever his profits are adequate.

His future mother-in-law, who joined in the conversation, offered him Rs.1000 as a debt, with 10% interest, however, with an option of offering her a partnership at next Diwali, based on the profits.

Soma, rather than jumping to the opportunity, asked for some time to think on whether he can take such a big loan and if he can take the responsibility of returning and servicing the money.

Lesson

Preference Capital

• When several investors contribute to the capital of the business with the condition that every year they will get a fixed rate of return, subject to the company earning profits, then this capital is termed as Preference Capital.
• Preferential shareholders, as the name suggests, enjoy a preferential right over equity shareholders with regards to:

1. Receipt of dividend which is fixed
2. Receipt of residual funds after liquidation, i.e. in the event of the company closing down, the preference shareholders will first receive their capital.

Debenture Capital

• A Debenture is a contract where the company will pay the lender the initial amount (principal) and interest (rate of interest predefined at the beginning) after a pre-defined period of time (maturity date).
• Debentures can be convertible or non-convertible.

1. Convertible Debentures can be converted into equity after a specified period of time. These debentures may or may not carry interest till the date of conversion.
2. Non-convertible Debentures cannot be converted into equity shares and will be redeemed at the end of the maturity.

Next: Venture Capital