A debenture as a long-term financing tool for companies – the law and practice

0
A debenture as a long-term financing tool for companies
Richard Nunekpek, Author

The Start Column

In the 22nd October 2021 publication of the B&FT Newspaper, the Chief Executive Officer of UMB Bank, Nana Dwemoh Benneh speaking at the 10th Ghana Economic Forum during a panel discussion on the topic “Contemporary approaches to financing start-ups; insights from key industry players” was reported to have said, “Bank loans are not for start-ups”.

In support of his conclusions, Nana Dwemoh Benneh said “When you want to build a business, you first have to look to patient capital. The initial patient capital obviously would come from family and friends but beyond that, you now need some sort of entity which gives the sort of capital that helps you to build up. With that, you can then come to a bank which can offer additional financing support for your short to medium-term requirements.

The mistake that is often made is that we try to use short-term capital to finance long-term needs and before long, the short-term capital is demanded for and you wouldn’t have finished what you are trying to build”. He concluded by saying “so, what we are trying to encourage is for most entrepreneurs to look at various types of financing and choose the one that is appropriate for their needs.

It is in the light of his recommendations that I shall look at Debentures as a long-term financing tool available for businesses. In this article, I shall discuss debentures, its usefulness, and obligations within the permission of law and practice in assisting companies to raise funds for their operations.

The concept of a “debenture”

Although the Companies Act, 2019 (Act 992) does not define a debenture, it provides an extensive list of monetary obligations on a company as constituting a debenture. Examples include a bond or an obligation, a loan stock, an unsecured note, or any instrument executed, authenticated, issued, or created in consideration of such a loan or existing indebtedness among others.

From the permissible list, Act 992 admits a written acknowledgment of the indebtedness of a company as a defining characteristic of a debenture. The related indebtedness could be as a result of a loan granted or to be granted a company. Also, it could be in respect of money deposited or to be deposited with a company. Further, a debenture recognizes existing indebtedness of a company whether constituting a charge on any of the assets of a company or not.

However, not all types of a written acknowledgment of indebtedness constitute a debenture. The Companies Act, 2019 (Act 992) excludes a bill of exchange, a promissory note, a letter of credit, a policy of insurance, a deposit certificate, passbook, or other similar documents issued in connection with a deposit or current account at a banking company from being considered as a debenture.

Further, an acknowledgment of indebtedness issued in the ordinary course of business for goods or services supplied cannot be considered as a debenture. This makes a debenture a special type of acknowledgment of indebtedness by companies. To qualify as a debenture, firstly the indebtedness must be in writing, secondly it must be on terms indicating the company’s obligations to repay, and thirdly it must be concerning debt relating only to a company.

In the consideration of its terms, parties could decide to create a debenture instrument that is either perpetual or redeemable, convertible or non-convertible, secured or unsecured. These types of debentures have their inherent advantages and disadvantages which a company must consider carefully in its decision leading to the execution of a debenture.

As a general legal requirement, an executed debenture must be perfected through “stamping” which involves the payment of stamp duty which is a percentage of the value of indebtedness and registration with the Registrar-General to validate the charge created on the property(ies) of the company concerned.

A debenture as a debt financing tool

Debt financing is an alternative funding (to equity participation) legally permitted for companies. Commonly, a debt financing arrangement for a company could be in the ordinary course of its business involving the purchase of goods and services on a credit arrangement, bank loans, overdrafts, and other financial supports like bank guarantees or letters of credits, etc.

Mostly, these short-term debt supports are extended to companies based on their creditworthiness, ability to provide acceptable collateral, cashflow projections, and short-term liquidity/profitability considerations. By the eligibility criteria, a limited number of companies qualify to access short-term debt financing facilities either from banks and other financial institutions or 3rd party vendors.

For the excluded companies such as start-ups, small and medium-sized businesses, debentures are the preferred option for raising long-term funds.

A debenture-holder can negotiate flexible repayment terms including interest rates with a company and this is usually influenced by his or her general interest in the sustainable operation of the company. By negotiating, a debenture-holder can accept a charge over assets that ordinarily financial institutions will not accept as collateral for funding requested by a company.

In some instances, a debenture-holder may opt for the conversion of debt into equity thereby relieving the company of any repayment commitment. The flexibility with which a debenture is discussed, agreed, or created – whether secured with a charge or not, executed and performed makes it a suitable debt funding option for businesses exploring funding outside the traditional financial institutions.

Obligations associated with a debenture

As a legal instrument, debenture does not only create benefits for companies. It imposes obligations and burdens on their operations once created. Although debenture-holders are not shareholders of a company, their entitlements in respect of debt repayments and interests are a priority consideration over all other payment commitments including the payment of dividends.

Also, a debenture secured by a charge entitles the holder to seek an order of the court for the appointment of a receiver when the charge becomes enforceable or for the appointment of a receiver or manager where the security of the holder is in jeopardy. A receiver appointed by the exercise of this right resulting in a liquidation process places the payment of debenture liability in priority over any other debts.

Apart from the entitlement of debenture-holders, a debenture imposes some of the following obligations and burdens on a company:

  1. Limitations on how the company may deal with assets secured by a fixed charge or when a floating charge becomes enforceable.
  2. The obligatory nature of the repayment commitment on principal and interests especially for non-convertible, perpetual debentures which become payable on the occurrence of contingent events or redeemable ones.
  3. In the case of convertible debentures, the obligation to convert debt into shares reduces existing ownership percentages for shares.
  4. Reduction in borrowing capacity of a company where a debenture limits any further borrowing.
  5. Regulatory demands of perfection, registration, and maintenance of a debenture register including the development of debenture compliance checklist.

Conclusion

Companies require funding to support their operational activities. Equity and debt financing have been the two broad ways of achieving this. However, the traditional avenues for raising debt financing have been complicated with strict demands most start-ups, small and medium-sized companies cannot meet. It is therefore important for owners and managers of these types of companies to explore other long-term debt financing options like a debenture and a clear understanding of the regulatory regime is important in such pursuit, a purpose this article has sought to achieve.

>>>the writer is is the Managing Partner of Sustineri Attorneys PRUC, a client-centric boutique law firm specialized in transactions, corporate legal services, dispute resolutions, and tax. Richard is also a research and teaching assistant for the Commercial Law Course at the Faculty of Law, Ghana Institute of Management and Public Administration (GIMPA). He will welcome views on this via [email protected]

Leave a Reply