Capital debt is a source of long term fund. A company generates these funds by promising to pay interest and capital repayment on the out- standing balance on the loan.
Debentures and unsecured loan
A debenture is a legal agreement by which a company acknowledges a loan. The trust deed to the debenture will record a statement of the interest payable, the term of repayment of the principal and any other charges that are agreed. A floating charge implies that the debenture holder has a general claim against all the assets of the company. Such a flexible arrangement allows the financial manager a reasonable degree of freedom within which to manage the company's assets. Where however, a debenture is secured against a particular asset, (mortgage debenture) there is less freedom to manage the asset. Debenture poses more risk to the company than unsecured loans. If a company is unable to meet any
of the conditions of the trust deed securing the debenture, the trustee
being rigidly controlled by statute, has little time to negotiate e.g. the trustee cannot delay action against a defaulter, as distinct from the case of unsecured loan stock where delays can be arranged in order to revise interest and repayment schedule. To default on a debenture gives the trustee the right to introduce a receiver to manage the company's affairs.
This will lead to liquidation and also implies forced sale of assets. A debenture has a prior charge against the assets of the firm. It is also places restriction upon all the borrowings of the firm. This frequently entails severe restriction on overdraft. Unsecured loan stock however places less restriction on other borrowings.
Debenture and loan stock may be issued with a provision for conversion into ordinary shares under specific conditions