Understanding Loan Capital
Loan capital refers to the funds that a company raises through borrowing. This can be achieved through various means, including loans from banks, issuing bonds or debentures, and obtaining mortgages. Loan capital is considered a liability on the balance sheet and must be repaid over time, typically with interest. Companies often prefer loan capital because it does not dilute ownership as equity financing does. The key characteristics of loan capital include:
- Repayment Obligation: Unlike equity financing, where investors gain ownership stakes in the company, loan capital must be repaid according to agreed-upon terms.
- Interest Payments: Borrowing incurs interest costs, which can vary based on the creditworthiness of the borrower and prevailing market rates.
- Tax Benefits: Interest payments on debt are often tax-deductible, providing a financial advantage compared to equity financing.
Debentures/Loan Notes
Debentures are a specific type of loan capital that companies issue to raise funds without offering collateral. They are essentially unsecured bonds backed only by the issuer’s creditworthiness. Key aspects of debentures include:
- Unsecured Nature: Debentures do not have specific assets pledged as collateral; instead, they rely on the issuer’s ability to repay based on its financial health.
- Long-Term Investment: Debentures typically have longer maturities (often exceeding ten years) and pay periodic interest known as coupon payments.
- Types of Debentures:
- Registered vs. Bearer Debentures: Registered debentures are recorded with the issuer for interest payment purposes, while bearer debentures are unregistered and can be transferred simply by delivery.
- Redeemable vs. Irredeemable: Redeemable debentures specify a repayment date, whereas irredeemable (or perpetual) debentures do not require repayment at any fixed time.
- Convertible vs. Nonconvertible: Convertible debentures allow holders to convert them into equity shares after a certain period, while nonconvertible ones cannot.
Debenture issuance is governed by an indenture—a legal contract detailing terms such as maturity dates and interest calculations.
Mortgages
Mortgages represent another form of loan capital specifically tied to real estate transactions. They involve borrowing money secured against property assets:
- Secured Debt: Mortgages are secured by the property itself; if the borrower defaults, lenders can seize the property through foreclosure.
- Amortization Structure: Mortgages typically involve regular payments over time that cover both principal and interest until the debt is fully paid off.
- Types of Mortgages:
- Fixed-Rate Mortgages: These have a constant interest rate throughout the life of the loan.
- Adjustable-Rate Mortgages (ARMs): These have variable interest rates that may change periodically based on market conditions.
Mortgages are commonly used by individuals for home purchases but can also be utilized by businesses for acquiring commercial properties.
In summary, loan capital encompasses various forms of borrowing including debentures and mortgages—each serving different purposes within corporate finance structures while providing companies with necessary funding without diluting ownership.
