Companies borrow money from a range of sources, including their directors and shareholders, personal contacts, banks, venture capital companies, institutional investors and the general public through the Stock Exchange (Public Limited Liability Companies only).
A debenture is the traditional name given to a medium to long term loan agreement or instrument used where the borrower is a company (issuer) and the lender is either an individual or another company. Typically, a debenture will set out the terms of the loan: the amount borrowed, repayment terms, interest, charges securing the loan, provisions for protecting and insuring the property etc., and terms for enforcement if the company defaults. A debenture is transferable and may be held to maturity or traded upon the stock exchange.
Debentures are usually unsecured instruments, backed only by the general creditworthiness and good reputation of the issuer; however, they may be secured by a fixed or floating charge on the current and future assets of the company.Should the issuing company not be able to repay the amount borrowed, the investor can lay claim on the assets of the issuer, and either appoint a receiver to manage the assets and apply the revenues derived therefrom to paying off the loan or exercising the power to sell the assets of the company and apply the revenues to paying off or liquidating the debt.
A debenture may be convertible into shares at a specific date or upon the occurrence of certain specified events or it may be non-convertible. As a general rule, convertible debentures carry a lower rate of interest than non convertible debentures. At the end of the lending period, issuing companies usually offer the choice of converting the debentures for shares (stock or equity).
If you wish to invest in debentures, there are some things to consider:
- Credit risk of the issuer: By investing in a debenture, you are lending your money to a business, with all the risks that this involves. You should examine the revenues and operations of the company to ensure you are not throwing good money down a black hole.
- The debt‐equity ratio: The investor should consider the ratio in which debt is used to finance projects and capital compared to that used for equity. If more debt is used to finance the company, the risk of default and the possible outcome of the insolvency of the company should be considered.
- Liquidity of the company: This refers to a company’s ability to turn their assets into cash and how quickly. If the company has a reputation of being unable to pay interest on loans taken, stay away!
Milton and Cross offers investment advisory and preliminary due diligence services to individuals desirous of investing in debentures and other equity or debt securities. We may be contacted by telephone on +2348036258312; and by email on email@example.com.