Answer to Question #238875 in Management for A.v

Question

Darren and Lyle are both business owners who run well-established and
sizeable plumbing and water systems firms in East London and Alice. A
recent drought has left the two towns water supply extremely depleted,
and Darren and Lyle decide that they want to buy 5 000 desalination units
and sell them at a high profit. They decide that they could merge their
businesses to shoulder this new venture together. Lyle is convinced that
debentures are the way to finance this endeavour. Is he correct? Explain
your reasons for or against the use of debentures to fund young business
ventures such as this.

Answer 1

• Debentures ensure a higher position in the ‘pecking order’ for repayment as a creditor. Otherwise, the loan is unsecured - the position of unsecured creditors near the bottom of the payment hierarchy means a significantly lower chance of recovering any money.
• Valuable financial protection and reassurance is provided for directors as regards their personal funds.
• The use of debentures can encourage long-term funding to grow a business. It is also cost-effective when compared with other forms of lending.
• Debentures usually provide a fixed rate of interest for the lender, and this has to be paid before any dividends are issued to shareholders.
• Control of the company by existing shareholders is not reduced, and profit-sharing remains in the same proportion.