(218-219) Debt, a form of security, can be sold privately or in a public offering and be publicly traded. Debt is a fixed claim against the coporation for principal and interest. The major types of debt are trade debt, bank debt, bonds, debuntrues, and notes.

  • Trade debt - when a business purchases goods or services, payment is typically not due for thirty, sixty, or ninety days. Trade debt consists principally of amount that a corporation owes for such goods and services at any point in time. Trade debt appears on a corporate balance sheet as Accounts payable.
  • Bank debt - a business will often be financed in significant part by commerical-bank loans. Bank loans appear on a corporation's balance sheet under captions such as Loans Payable.

Long term debt instruments are often denominated as:

  • 1) bonds - bonds are usually secured by specific assets, which means that in the case of default, the bondholders may usually claim payment from specific assets of the business (similar to a bank holding a mortgage on a home).
  • 2) debentures - debentures involve unsecured debt. Holders of debentures have a general claim to assets with other unsecured creditors.

The relationship between the creditor and the corporation is contractual.

  • There may be contractual provisions that limit corporate activiites to protect the loan and may give the creditors some limited control. If the debt is sold to the public, the contract is called an indenture and a trustee may be selected to represent the interest of the public debt holders.

Since debt has priority over equity for both interest and payment of principal, it generally has less risk of loss than equity. Credtirs are concerned with the success of the business because it will help to insure repayment of interest and principal. However, creditors do not usually receive more if the business is successful.