Debt Investment Overview

  • Debt financing is raised by companies through the issuance of securities called Promissory Notes, Senior Notes, Senior Secured Notes or Subordinated Notes.  These terms indicated the underlying credit structure of a given debt security and are described below. 
  • The amount of debt financing which can be raised by companies through private placement offerings in amounts ranging from less than $100,000 to well over $1,000,000,000.  
  • Maturities (i.e. when the principal is due to be repaid) can be short-term (say 90 days) to over 10 years.  In many cases, “amortizing” principal repayment is established when the debt security is issued.  Amortization involves the scheduled, partial return of principal over the life of the debt security.
  • The repayment schedule of a debt security should match the projected cash flow to be generated by the security issuer’s business during the period the debt security is outstanding so the company can repay the borrowed capital when it is due.  
  • The debt’s maturity should generally match the Issuer’s intended use of the funds.  For example, funds to be used for short term working capital (such as financing accounts receivable or inventory accumulation) should generally involve a maturity less than one year whereas funds for capital expenditure (equipment acquisition, property acquisition or facility enhancement) will involve a security with a maturity of greater than one year. 
  • Debt securities are also referred to as “fixed income” securities because they provide investors with a specified rate of return through payment of an annualized interest rate that is typically paid by the issuer monthly or quarterly on the outstanding principal balance.  Equity securities, on the other hand, provide investors with a share of the issuer’s profits, but after the Issuer’s payment obligations of all debt securities or loans have first been satisfied.
  • Interest rates may be fixed for the life of the security or they may set in relation to a recognized index, such as the US bank Prime Rate or LIBOR.  The rate paid for such floating rate notes will therefore go up or down as the underlying indexed rate changes as a result of overall credit market shifts.
  • Lower credit quality issuers should pay a higher rate of return to investors than stronger credit quality issuers.  
  • Longer maturity securities typically require a higher interest rate than shorter term securities of a comparable credit issuer.  
  • The credit strength of a debt security and the related investor demand can be enhanced by “collateralizing” the security with a lien on the assets of the issuer and which has recognized value.   In the event that the issuer cannot otherwise meet its redemption obligations these assets can be unilaterally sold by the investor to achieve a return of their investment.  Such securities are referred to as Secured Notes. 
  • As a means to offer a greater potential return to the investor, debt securities may also incorporate warrants, a form of purchase option for equity securities of the issuer.   Offering warrants with a debt offering may be necessary to generate investor demand given the risk profile of the debt security being offered.
  • Debt securities can be issued whose repayment priority is specifically subordinated to other debt securities of the issuers.  These are referred to as “subordinated debt” and also as “mezzanine financing” and their total returns provided investors will typically be higher than the senior debt securities of the Issuer.
  • Not paying the principal or interest when due on a debt security results in a “default” event and trigger events that can restrict the issuer’s operations until the default is “remedied”,potentially forcing the issuer’s bankruptcy and liquidation.  Therefore, debt should only be offered by companies having a base of operation that generates sufficient cash flow to meet the principal and interest payments specified by the security offered.
  • Debt securities can be structured for continual issuance in “tranches” when there is an ongoing need for debt financing by an issuer, but not all of the capital is required a particular point in time.
  • Credit ratings on a specific private debt security, which can be assigned from third parties such as a nationally recognized rating service such as Moody’s InvestorsService, Standard and Poor’s Corporation or the NAIC, can significantly increase investor demand while reducing the interest rate required by investors.  Credit ratings are only available for the debt securities of larger, well-established companies.