Cambridge AS A Level Business Studies/ ZIMSEC Advanced Level Business Studies/ Business Enterprise Skills Notes: Types of businesses: Limited Companies: Debentures

  • In addition to raising capital (money) using shares,
  • Companies also often raise money by issuing (selling) debentures
  • While shares are considered as a part of (or a unit of) capital debentures are considered a loan
  • A debenture can there be defined as a loan stock that is issued by a company to creditors in exchange for funds
  • Usually, it takes the form of promissory note where the issuing company promises to pay the creditor who is lending them funds the specified amount after the specified period has lapsed
  • The word debenture is simply used to describe that document or certificates that acknowledge said loan
  • The word debentures is also used to refer to the total amount the issuing company has borrowed this way
  • Debentures are creditors to the company and are, in the event of liquidation,
  • The first to receive their monies.
  • They usually earn a fixed rate of interest on the amount that they have given to the company
  • For example, a 7% debenture earns a rate of 7 cents for each dollar the company borrowed
  • Debentures are typically redeemable or at least convertible (see below for definitions to these terms)
  • Just like shares debentures are also traded publicly on the financial markets

Types of Debentures

Convertible debentures

  • These can be converted into one form of stock or another for example into ordinary shares,
  • This conversion is usually at the discretion of the of the debenture holder at a predetermined future date
  • The rate is often agreed upon by the issuing company and the debenture holder when the debentures are issued out
  • For example, Debentures can have the option to be converted into either Ordinary or Preference shares after a certain date

Naked debentures

  • These are also known as simple debentures,
  • They are issued without security and are only backed by the issuing company’s word that they will repay the borrowed amount
  • They are unsecured and not tied to any specific asset within the issuing company
  • These debentures are considered insecure in the event of liquidation since they have to wait in line with other creditors although they are entitled to receive their money before the shareholders
  • While they may seem undesirable at first glance in reality
  • These types of debentures are backed by the reputation and integrity of the borrower
  • This might be enough for trusted businesses that are large, well known, of sound financial standing
  • Examples include Multinational companies and big technology entities such as Google, Alibaba etc

Floating debentures 

  • Such debentures are secured by floating amounts on all the assets of the company
  • Such assets may be buildings, land, other fixed assets or movable assets such as motor vehicles etc
  • These debentures are typically secured on unspecified assets of the business
  • The understanding is that if the company defaults some of its assets will be sold to settle that debt
  • Unlike mortgage/fixed debentures the debenture holder does not place any restrictions on the borrowing company’s use of the assets used to secure the debenture loan

Mortgage debentures

  • these debentures are secured on the more permanent assets of the company such as Plant Property and Equipment or Buildings
  • They are sometimes also known as fixed debentures
  • Fixed debenture holders often place restrictions upon the borrowing company’s use of the assets upon which the debenture loan is secured
  • Often these restrictions prevent the company from selling the asset without the approval of the debenture holders

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