DEFINITION of Trust Certificate
A trust certificate is a bond or debt investment, usually in a public corporation, that is backed by other assets. These assets serve a purpose similar to collateral. If the company experiences difficulty making payments, the assets may be seized or sold to help specific trust certificate holders recover a portion of their investment. The potential type of company assets used to create a trust certificate can vary, but most typically are other shares of company stock or physical equipment.
BREAKING DOWN Trust Certificate
Investors holding trust certificates usually experience a higher level of safety than investors owning unsecured or uncollateralized bonds. Yet they also typically earn a lower level of interest than those investors willing to take greater risks. While that may sound like an attractive balance for some investors, investing in trust certificates can be complex, because it requires both an understanding of a company's overall financial situation and the nature of the asset that underlies the trust certificate.
Special caution should be taken when investing in trust certificates with an underlying asset that is the same company's stock. If the company runs into financial trouble, the asset backing the trust certificate can become as worthless as the trust certificate itself.
Trust Certificate and Financial Analysis
It’s important for investors to undertake deliberate financial analysis prior to investing in a trust certificate. While a trust certificate differs in some respects from the company’s common stock, it still reflects the company’s overall situation with respect to stability and future growth. Financial analysis can help determine if the company in question is, solvent, liquid, and/or profitable enough. Investment analysts should take time to dig into the the company’s income statement, balance sheet and cash flow statement, along with management earnings calls, industry news, and other sources of information.
Trust Certificate and Liquidation of Assets in a Bankruptcy
If and when a company goes bankrupt, its assets are distributed to lenders and shareholders in a specific order. Investors or creditors who have taken the least risk are paid first. These include those who have purchased trust certificates and other forms of secured debt (often banks), followed by holders of unsecured debt. These holders can include banks, along with suppliers and bondholders. After this, equity holders – first preferred shareholders and then common shareholders are repaid if any funds remain. If the company is out of funds, equity holders may not even receive a fraction of their investment.