A form of long term debt raised after a company sells debenture certificates to the holder and raises finance in return. The term debenture has its origin from ‘DEBOE’ which means ‘I owe’ and is thus a certificate or document that evidences debt of long term nature whereby the person named therein will have given the issuing company the amount usually less than the total par value of the debenture. These debentures usually mature between 10 to 15 years but may be endorsed, negotiated, discounted or given as securities for loans in which case they will have been liquidated before their maturity date. The current interest rate is payable twice a year and it is a legal obligation.
i) Secured Debentures
These are those types of debentures which a company will secure usually in two ways, secured with a fixed charge or with a floating charge.
a) Fixed Charge – a debenture is secured with a fixed charge if it can claim on a specific asset.
b) Floating charge – if it can claim from any or all of the assets which have not been pledged as securities for any other form of debt.
ii) Naked Debentures
These are not secured by any of the company’s assets and as such they are general creditors.
iii) Redeemable Debentures
These are the type of debentures, which the company can buy back after the minimum redemption period and before the maximum redemption period (usually 15 years) after which holders can force the company to receivership to redeem their capital and interest outstanding.
iv) Irredeemable Debentures (perpetuities)
These are never bought back in which case they form permanent source of finance for the company. However, these are rare and are usually sold by company’s with a history of stable ordinary dividend record.
v) Classification according to convertibility
Convertible debentures – Can be converted into ordinary shares although they can also be converted into preference shares.
Conversion price = par value of a debenture/No. of shares to be received.
Conversion ratio = Par value of debenture
Par value of ordinary shares
ABC Company Ltd books:
10.000, Sh.20 ordinary share capital
10,000, Shs.10 8% preference share capital
5,000, Shs.100 12% debentures
The above debentures are due for conversion:
i) Compute the conversion price
ii) Compute the conversion ratio
iii) Compute new capital structure.
i) Conversion price = par value of debenture/No. of shares to be received.
No. of shares to be received = 100:20 = 5:1
ii) Conversion ratio = par value of debenture/par value of share =
Receive 5 ordinary shares for every 1 debenture held.
iii) New capital structure
No. of new ordinary shares = 5000 x 5 = 25,000
35,000, Shs.20 ordinary shares 700,000
10,000, Shs.10, 8% preference shares 100,000
Total capital 800,000
vi) Non-convertible debentures
These cannot be converted into ordinary preference shares and they are usually redeemable.
vii) Sub-ordinate debentures
Usually last for as long as 10 years and they are sold by financially strong companies. Such are not secured and they rank among general creditors in claiming on assets during liquidation. This means that they are sub-ordinate to senior debt but superior to ordinary and preference share capital.
Reasons behind Unpopularity of Debentures of Kenya’s Financial Market:
i) Their par value is an extremely high value and as such they are unaffordable to purchase by would be investors.
ii) They are in most cases secured debt and as such constrain the selling company in so far as getting sufficient securities is difficult.
iii) Most of the would-be sellers have low credit worthiness which is difficult.
iv) Kenya’s capital markets are not developed and as such there is no secondary debenture market where they can be discounted or endorsed.
v) Debentures finance is not known among the general business community and as such many would be sellers and buyers are ignorant of its existence.
vi) Being long term finance there are a few buyers who may be willing to stake their savings for a long period of time.
vii) Such finance calls for a fixed return, which in the long rum will be eroded by inflation.