Companies use debentures, secured and unsecured notes to raise money from investors. They offer fixed interest payments but returns often depend on risky investments. You could lose all your money if the company or investment fails.
How debentures, secured and unsecured notes work
Companies set the interest rate on the debentures, secured and unsecured notes in advance. In return, the company promises to:
- make regular interest payments
- return the money ('the capital') you lend them at a date in the future
Companies use debentures because they are a cheap way for them to borrow money. They have lower interest rates and longer repayment dates compared to other types of loans.
What companies do with your money
The company might use your money to finance a range of investment activities. Or it may on-lend your money to another business.
The security offered by the company determines the name of the investment.
- Debentures – if 'tangible property' (real estate, land, equipment, for example) is offered as security.
- Secured notes – if a 'first ranking' debt over other property is offered as security.
- Unsecured notes – no security offered.
The risks of debentures, secured and unsecured notes
Debentures, secured and unsecured notes offer higher interest rates than bank deposits. They also carry higher risks.
No guaranteed returns
There's no guarantee the company will pay you interest. Or return your capital. You could lose all the money you've invested if the company or project fails.
Money locked away
Debentures and notes have set investment periods, for example 1, 3, 6 or 12 months. Some have a set period of 5 years. You cannot ask for your money back before the set period expires, unless they are 'at call'. Some companies may repay your money early on hardship or compassionate grounds. There is usually a penalty for getting your money early.
Unlisted investments can be hard to sell
Debentures, secured and unsecured notes are 'unlisted' investments. This means you can't buy and sell them on a market like the Australian Securities Exchange (ASX). Instead, you deal directly with the company issuing the debentures and notes.
Because the debentures are unlisted:
- you can't see if the price of the investment is going up or down
- it may be difficult to sell them if you decide you no longer want them
What to check before buying debentures and notes
There are a few things you can do to understand the investment and the risks.
Read the prospectus
The prospectus tells you how the company will use your money. For example, will they use it to finance their own investments? Or will they on-lend your money to another business?
The prospectus will also tell you the return being offered to investors. Will it compensate for the risks?
Get financial advice if you need help understanding the prospectus.
Understand the business model
How does the company make its money? What are they going to do with your money? If you can't explain these things to a friend, stick to a safer investment where the risks are clearer.
Before the end of the set period, the company will contact you about extending your investment. If you do nothing, the company will 'rollover' the debenture for the same period as the original investment. You will not be able to access your money until the end of the new period.
The company's business or financial position may have changed since you lasted invested. Check their financial report for the year to assess the value of your investment. See keep track of your investments for tips on checking how your investment is performing.
Check the benchmarks
There are eight benchmarks that apply to debentures and unsecured notes. These help you assess the company's business model and identify risks.
Investing in unlisted debentures and unsecured notes
How to use benchmarks to decide if you should invest.
What to do if things go wrong
If something goes wrong with your investment you may be able to recover some of your money.
Contact the company with a formal complaint. See how to complain.
Mary loses her money in a secured note
Mary was reading the newspaper when she came across an ad for a new secured note. The company in question was offering an interest rate of 8.5% p.a. on a minimum investment of $5,000 for a term of 5 years. The interest rate seemed too good to pass up. Mary decided to invest $50,000 of her retirement savings.
The company planned to use investors' money to on-lend to property developers. Six months after Mary invested, the finance company went bust. The company directors had overestimated the company's assets. There was no return to investors. Mary lost a big chunk of her hard earned retirement savings.