Straight debt definition
/What is Straight Debt?
Straight debt is a written unconditional promise to pay a fixed amount, either on demand or by a specified date. It is not convertible into the equity of the issuer.
Straight Debt Issues in an S Corporation
The concept of straight debt is a particular concern in an S corporation, where any debt that is not straight debt can be considered a second class of stock. When this is the case, the firm’s S corporation election can be rendered invalid.
Examples of Straight Debt
Here are three examples of straight debt:
Corporate bonds. A manufacturing company issues 10-year corporate bonds with a fixed interest rate of 5% per annum. Investors who purchase these bonds receive interest payments semi-annually and are promised the return of the principal amount at the end of the 10-year term. Since the bond has a fixed repayment schedule and interest rate, it qualifies as straight debt.
Bank term loans. A retail business takes out a $500,000 term loan from a bank with a fixed interest rate of 6% and a 5-year repayment schedule. The loan agreement specifies monthly payments of principal and interest, with no options for conversion to equity or other contingencies. The fixed repayment terms make this loan a straightforward example of straight debt.
Government bonds. A government issues treasury bonds with a fixed coupon rate of 3% and a maturity period of 20 years. Investors receive annual interest payments and are guaranteed the return of their principal at maturity. The fixed interest and repayment terms classify these bonds as straight debt instruments.
These examples illustrate how straight debt involves clear, unconditional obligations to repay fixed amounts on specified terms.