Debt Finance

Question 1

Definition

Answer 1

When businesses obtain finance by borrowing money.

Question 2

Types of debt finance

Answer 2

2 types:
1) Loan
2) Debt securities
What they both have in common is the fact that the company borrow money from a bank or an investor which it will then have to repay

Question 3

Loan - Definition

Answer 3

Where a business borrows money from a bank or another lender such as its owners or its directors or shareholders. 3 types of loan:
1) Bank overdraft
2) Term loan
3) Revolving credit facility

Question 4

Debt securities - Definition

Answer 4

IOUs which are issued by the company to the investor in return for a cash payment and have to be repaid by the company at an agreed future date

Question 5

Considerations prior to borrowing

Answer 5

Must check there’s no restriction under constitution. MAs do not place any restrictions. If there are any restrictions the shareholders will have to pass special resolution to change the articles. Business will often have to offer the lender security over its property in return for the money.

Question 6

Secured loans - Definition

Answer 6

Involves the business giving security to the lender over some or all of its property so that the bank can recover what it is owed more easily if the business defaults on the loan

Question 7

Unsecured loans - Definition

Answer 7

If the lender does not take security over the borrower’s assets the loan is unsecured. Businesses pay higher rates of interest for unsecured loans

Question 8

Loans - Overdraft facility - Definition

Answer 8

A contract between the business and its bank which allows the business to go overdrawn on its current account. Type of temporary loan used to cover everyday business expenses where is no other source of money available.

Question 9

Loans - Overdraft facility - Uncommitted facility

Answer 9

It is known as an uncommitted facility - it will usually be payable on demand. The bank may demand immediate repayment by the business at any time without giving any notice.

Question 10

Loans - Overdraft facility - Fees

Answer 10

The business will have to pay a fee for the overdraft facility. The bank will also charge interest by reference to its base rate which is the rate at which the bank is prepared to lend to its customers with the best credit rating

Question 11

Loans - Overdraft facility - Advantages

Answer 11

It is a flexible source of finance and relatively few formalities are required to arrange it

Question 12

Loans - Overdraft facility - Disadvantages

Answer 12

Repayment may be demanded at any time by the bank. It is also a relatively expensive way to borrow as it is usually unsecured and the banks charge high interest rates in return for offering such flexibility

Question 13

Loans - Term loans - Definition

Answer 13

In a term loan the business borrows a fixed amount of money, usually from a bank for a specified period at the end of which it must all be repaid. The borrower must pay interest at regular intervals.

Question 14

Loans - Term loans - Short-term

Answer 14

Short-term loans are usually for up to one year

Question 15

Loans - Term loans - Medium-term

Answer 15

Usually for 1-5 years

Question 16

Loans - Term Loans - Long term

Answer 16

5+ years

Question 17

Loan - Term Loans - When they are used

Answer 17

They are typically used by a business to purchase a capital asset such as land, building or machinery

Question 18

Loan - Term Loans - Bilateral loan

Answer 18

This is between two parties, the business and the bank

Question 19

Loan - Term Loans - Syndicated Loan

Answer 19

Between business and a number of different lenders who jointly provide the money the business wants to borrow. These are common when the amount of the loan is high and the risk of lending is shared between a number of banks.

Question 20

Loan - Term Loans - Advantages

Answer 20

If they take the money in instalments it will reduce their interest payments. It gives greater certainty than an overdraft, the borrower has greater control because the bank can only request repayment under the terms of the contract.

Question 21

Loan - Term Loans - Disadvantages

Answer 21

Time and expense in negotiating and agreeing all the legal documentation for such a loan and the fact that once repaid the money cannot then be re-borrowed

Question 22

Loan - Revolving credit facilities - Definition

Answer 22

In a revolving credit facility the bank agrees to make available a max. amount of money to the business throughout the agreed period of the revolving credit facility. During the lifetime of the facility the business can borrow and repay money. Interest is payable at regular intervals. Business is also able to reborrow amounts that it had already repaid so long as it does not exceed the overall max. figure

Question 23

Loan - Revolving credit facilities - When they will be used

Answer 23

Useful businesses whose income is not evenly distributed throughout the year

Question 24

Loan - Revolving credit facilities - Advantages

Answer 24

It is a very flexible means of borrowing money and it is possible to reduce the total amount of interest payable by reducing borrowings

Question 25

Loan - Revolving cred facilities - Disadvantages

Answer 25

Time and expense in negotiating and agreeing all the legal document for the loan and the high fees that are charged

Question 26

Loan - Facility agreement

Answer 26

This is the contract entered into for a term loan or a revolving credit facilities. It will include repayment and pre-payment and interest rates, express covenants

Question 27

Debenture - Definition

Answer 27

Gives the lender security over the borrower’s assets