Chapter 3 - Debt as a Source of Funding Flashcards
List 6 Advantages of Debt Finance
1) Low Cost of Capital
2) No Ownership Dilution
3) Tax Deductibility of Interest
4) Corporate governance and strategic decision-making is usually not impacted significantly
5) Less Costly and time-consuming to raise capital compared to equity
6) Can better optimize company’s weighted average cost of capital
List 6 Disadvantages of Debt Financing
1) Use of Funds can be restricted or limited by covenant
2) Bankruptcy and default risk is heightened when companies take out too much debt
3) Regular financial reporting requirements
4) Rigid, inflexible payment requirements
5) Onerous penalties associated with financial covenant breach or late payments
6) less alignment of interest between lender and investor, compared to equity financing
List 4 Common Financing products issued by banks and credit unions
1) Revolving Lines of Credit
2) Senior Secured Term Loans
3) Asset-backed loan facilities
4) Mezzanine Finance
List 4 Different classes of Debt Investors
1) Banks and Credit Unions
2) Private Credit Providers
3) Institutional Investors
4) Public Debt Markets
What basic Rights are common to most credit arrangements?
1) Principal Repayment / recovery
2) Interest Payment
3) Financial Reporting
4) Call the Loan
5) Default Remedies
6) Seize Assets
What are the key differences between Loans & Bonds?
Bonds are more flexible regarding liquidity and restrictions on other debt issuances. Can also reduce refinancing risks of interest rate variability. Loans have smaller maturities however higher liquidity risk and tend to be rigid with financial monitoring and impacting business operations.
What are the key differences between Secured debt & unsecured debt?
Secured debt is secured by collateral. In the event of default, secured lenders can seize pledged collateral to recoup loss. Interest rates tend to be lower with secured debt, unsecured lenders prefer companies with very high credit ratings or senior positions within capital structure to mitigate any risk.
What are the key differences between Senior Debt & Junior Debt?
Senior debts hold priority of principal and interest repayment over all other forms of debt. Junior debt is secured debt. Lenders prefer senior debt as in the event of default or bankruptcy they will have the highest likelihood of recovering their investment.
What are a few key differences between Cash Flow Lending Vs. Asset Based Lending? (describe asset based lending, Spencer is going to dominate this module my word)
Asset-based lending focuses mainly on the value of specific assets on the balance sheet starting with the most liquid assets such as account receivable, inventory, and equipment. COvenants are usually tied to these assets, with debt levels allowed to increase with the value of assets as business grows.
Asset-based lending favors businesses that are highly levered, have a complex model, lack a strong financial performance track record, experience restructuring, have high levels of working capital, maintain fewer, larger customers demanding longer credit terms, anticipate strong growth, hold assets difficult to finance (airplanes)
What is Factoring?
Factoring is effectively a variation of Receivables Financing (invoice discounting or invoice factoring) occasionally referred to as a variation of asset based financing. Commonly seen in B2B transactions - whereby receivables are sold to a third party and the risk of collection lies solely with the factor.
List 7 Common Financing Instruments
1) Operating Line of Credit (Revolving)
2) Term Loans
3) Factoring (AR Financing)
4) Floor Plan Financing
5) Leasing
6) Vendor Take-Back Loan
7) Mezzanine Debt / Subordinated Debt
What is Floor Plan Financing?
A form of inventory financing focused on generally larger ticket goods like vehicles and household appliances. Its a 3 party arrangement whereby retailer purchases goods from supplier and the lender forwards payment to the supplier to create a credit line with the retailer.
Commonly used by retailers that have a high concentration of purchases with one supplier. Auto Dealers and equipment retailers make use of floor plan financing. Acquired inventories are utilized as collateral.
What are VTB’s?
Vendor Take-Back Loans arise during acquisition of a company by a third party, whereby previous owners receive loan from acquirer as part of purchase price consideration.
Debt is generally the most subordinated debt within capital structure and is often unsecured.
These Loans are used to facilitate completion of a transaction to provide seller with additional proceeds without requiring the purchaser to obtain additional debt from lenders or equity injections.
Briefly describe Mezzanine Debt / Subordinated Debt
Mezzanine Capital is a general term referring to the capital in-between senior debt and equity within a business. This typically takes the form of subordinated debt and may include other forms of capital like convertible debentures.
This debt has a general security over the agreement, but is lower priority than the senior debt (not paid first).
When is Mezzanine Debt Used?
This capital is largely used in situations where senior lenders are not willing to extend further debt, and the company wishes to avoid diluting shareholders. Commonly, this occurs during Leveraged buy-outs, or management buy-outs.
