What is a Debenture? Part 1

This post to day is brought to us by David Wolf – Affiliate Banker with BH Capital Ltd.

debentures

In the world of corporate finance, amidst the process of structuring the capital formation for client, part of our approach at BH Capital Ltd. involves effectively matching the appropriate form of capital to the project or business requiring that capital. A Debenture can be part of that process.

First, we might first consider the most basic question: Is equity or debt the appropriate form of capital, and what might be the optimal proportions of each?

A cornerstone of our approach says that “a business should never borrow it’s way out of trouble”. So as we consider debt financing as a solution, we must be sure that is not the application of proposed debt financing. To paraphrase George…“ First fix the management or business model, then apply the appropriate form of capital.”

A Debenture is One Form Of Debt Financing

In this instance, we are discussing debt financing. Assuming the business enterprise is on solid ground; that is, management is effective in its management, and assuming the core business is working, then debt is a perfectly appropriate form of capital. And a debenture is one of the forms of debt financing that may be considered.

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A debenture is essentially a bond that does not utilize real or specific assets or even personal guarantees as security in a transaction. Rather, it looks to the quality of the “good faith and credit” of the Corporation itself. In practice, we might find it appropriate for our client to issue a debenture where no other assets are available for collateral.

In order to succeed as an issuer of a debenture, the Corporation (issuer) must be profitable, effectively managed, and have been in business for a minimum of 5 years. Determining whether a Corporation is “sound” enough to issue a debenture requires an extraordinary level and depth of analysis. We have said many times that Corporations are essentially only as good as the people that run them. There is no truer measure of the quality of a business enterprise. As a prospective issuer of a debenture, the entity must be prepared for this kind of in depth analysis as we embark on the process of forming of debentures.

Beyond the people factor, the business must have the capability to service the debt being proposed. With no hard assets as collateral for the buyer of the debt, the effectiveness and efficiency of management, the revenues, the profitability and the cash flow (liquidity ratios) will be heavily scrutinized in the analysis.

The Debenture Approach Can Be a Win-Win Scenario

Ideally, if the enterprise meets the requirements to be a successful issuer, the debenture approach can be a win-win scenario for the both issuer and the buyer of debentures. There is a marketplace for transactions of this type and size. In the SMB universe, there is a market for debentures in the $1 to say, $5+ million range. Apart from those issued by large corporations in the hundreds of millions, there are buyers of this type of instrument. The art of matching risk, the pricing of that risk (interest rate) must be carefully considered in forming a solution that will work for both the issuer and the buyer. Hence, the debenture is a viable and unique debt financing solution that we look to facilitate for our clients, when appropriate.

Look for our next episode…a debenture story that you’ll find interesting and informative. Here’s to your success.

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David

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