Debt or Equity? The importance of knowing exactly what your investment is.

In recent times, we are noticing that investors are sometimes confused about precisely what rights their investment gives them. This is mainly because they are financial products (e.g. managed funds) are marketed as offering ‘fixed returns’, ‘preferred returns’ or ‘capital protected’. These are usually debt like concepts and investors can be forgiven in thinking that they are investing in some sort of equity instrument.

However, if you are obtaining units or shares in any structure, you are most likely investing in equity. These returns being claimed are not ‘promised’ and should be thought of as merely ‘target returns’. Under law, generally, returns to equity holders can only be made if the investment is in the financial position to do so. As such, it is very possible that if the business is unprofitable or has cash flow issues, you are unlikely to be entitled to the ‘promised’ distribution of income or capital. Unfortunately, that is the nature of equity and no promises of ‘capital protection’, ‘fixed return’ etc. will change that.

 So what can investors do to understand what they are investing in? Well, the first step will be to closely examine the disclosure document in relation to the investment (which depending on your circumstances is likely to be either a ‘prospectus’, ‘product disclosure statement’ or ‘information memorandum’). These documents should explain the structure and risks associated with the investment.

 Secondly, it is really important to understand the existing capital structure. What is its current debt and equity mix? What sort of rights are attached to the debt and equity and how do those rights rank relative to your rights? Answers to these questions will give you an understanding of where you rank in terms of receiving income and capital from the investment. Sometimes however, getting to the bottom of this can be complicated and you may wish to seek advice from a lawyer and/or financial advisor to more clearly understand your position.

 We frequently assist clients with understanding the structure of their investments. If you require any assistance on this, we would be pleased to assist.

IMPORTANT: The above has been provided for your general information only. It is not legal or financial advice and must not be relied on as such. Should you require advice in relation to your circumstances, we suggest that you contact us.