There are a number of reasons why an investor would chose debentures in preference to other forms of company financing. The major factor has to do with risk. Debt financing usually has a fixed maturity. The investor enjoys priority both in interest and in the possibility of the company going into liquidation. In addition,debenture holders receive a fixed return on the investment and if the company does not make large profits, will continue to receive the fixed interest rate while the ordinary shareholders may have to wait the Board's decision on what and how much to pay out. .
Now we must look at why a company would issue debentures. The primary advantage is that the cost of the debt is known and is limited. If the company makes greater profits, these are not shared out with the debenture holders. The cost of the debt is also limited because the risk of the debenture holders is lower than that of the shareholder. Also, and importantly, the interest payment that is made to the debenture holder is deductable against tax.
Debenture issues are not an unqualified benefit for the company. There are some disadvantages in that assumptions that were made ten years ago about the future trading position of the company might prove to be wrong and the decision for long term debt unwise. The company still has to repay the debt on the date of maturity.
A warrant, is in principle, a call option issued by the company on its own stock.The warrant holder is able to buy a specified number of shares at a specified price on a specified date. Problems that face the young company will be discussed later but for a company without a proven track record, raising finance can be difficult. The warrant can be used as an enticer. Debenture holders have no option to benefit from the company which performs well but companies can tempt investors to their debenture stock by issuing convertibles or warrents in return for lower interest rates in the immediate term.
