Classification of Debentures

Classification of Debentures

Classification according to security
i) Secured debentures- these are secured against the company’s assets or have a fixed charge against the company’s assets. In the event of the company’s liquidation such debentures will claim from that particular asset. They could be secured against a floating charge in which case the holder can claim on any or all of the company’s assets not yet attached by other secured creditors. A debenture holder with a floating charge has a status of a general creditor. However, the floating charges debentures are rare and they are sold by financially strong companies.
ii) Unsecured (naked) debentures- these carry no security whatsoever and such they rank as general creditors. They carry a residual claim to the first class creditors but a superior claim over ordinary shareholders. These are rare sources of finance and are sold by financially strong companies with a good record of dividend payment to the shareholders.
Classified according to redemption.
i) Redeemable debentures- these are bought back by the issuing company. Like preference shares, these have two redemption periods. This is usually between 10-15 years, i.e. the company has the option to redeem these after 10 years but before expiry of 15 years. In most cases redeemable debentures are secured against specific assets e.g. land or buildings (mortgage debentures). Their interest is a legal obligation on the part of the issuing company.
ii) Irredeemable debentures (perpetual debentures)- these can never be bought back by the issuing company except in the event of liquidation and as such they form a permanent source of finance to the company. These debentures are rare and are only sold by financially strong companies which must have had some good dividend history. They are unsecured and thus are known as naked perpetual debentures.
Classified according to convertibility
i) Convertible Debentures- These are the type of debentures which can be converted into ordinary share capital and this conversion is optional as follows:
i. At the option of the company i.e. at the company’s option.
ii. At the option of both parties i.e. debenture holder and the company.
iii. At the option of the holder.

However, the conversion price of the debenture s given by:-
Conversion Price = Nominal value of the debentures
Conversion Ratio = Nominal value of the debentures
Nominal value of the shares to be converted
In all, convertible debentures are never secured.
ii) Non-convertible debentures- These ciannot be converted into any shares be it ordinary or preference shares and are usually secured.

Subordinate debentures (naked)
These are issued with a maturity period of 10 years and above, and usually they carry no security and depend upon the goodwill of the company. They are so called subordinate because they rank last in claims after all classes of creditors except trade creditors. Nevertheless their claims are superior to those of shareholders both preference and ordinary shares.
Hire Purchase
This is an arrangement whereby a company acquires an asset by paying an initial installment usually 40% of the cost of the asset and repays the other part of the cost of the asset over a period of time. This source is more expensive than bank loans. Companies that use this source of finance need guarantors as it does not call for collateral securities to raise. The company hiring the asset will be required to honor all the terms of the arrangement which means that if any term is violated then the hire may repossess the asset. This finance is kind and the hirer will not get a good title to the asset until he clears the final installment and an optional charge in some cases. Companies that offer this finance in Kenya are:- National Industrial E.A. Ltd., Diamond Trust(K) Ltd., Kenya Finance Corporation, Credit Finance Co. Ltd. They avail hire purchase facilities for such assets as: Plant and machineries, vehicles, tractors, heavy transport machines, aircrafts, agricultural equipment

Lease Financing
Leasing is an important source of equipment financing. For some equipment, the financing is long term in nature. This section discusses the features of a lease their types and advantages and disadvantages of lease financing.
A lease is a contract whereby the owner of an asset (the leaser) grants to another party (the leasee) the executive right to use the asset in return for the payment of rent (i.e. lease payment). In other words, through leasing, a firm can obtain the use of certain fixed assets for which it must make a series of contractual periodic payments form the lease points of view; this lease payment is tax deducible. Here we discuss lease as an alternative source of financing and hence we shall see the effects of leasing on the lease business.

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