Debt Finance Flashcards
What are the two classifications of debt finance?
- Loan facilities
- Debt facilities
What is a loan facility?
An agreement between a borrower and a lender which gives the borrower the right to borrow money set out on terms of agreement
What are 3 kinds of loan facility?
- Overdraft
- Term loan
- Revolving credit facility
What is an overdraft?
What can bank demand?
An on-demand facility where bank can call all money owed to it at any point in time and demand it is repaid immediately
Unsuitable for long term; interest paid on amount overdrawn
What is a term loan?
A loan for a fixed period of time repayable on a certain date - early repayment cannot be demanded unless borrower in breach of agreement
Interest paid throughout
Bullet repayment = repayable in single lump sum at end
Amortisation = loan repayable in instalments
What is a revolving credit facility? What is the advantage of using one?
Loan for specified period of time but can repeatedly borrow and re-pay loans up to the agreed maximum overall amount when it chooses - helps keep interest payment down for borrower (as only borrows when it needs to)
What are debt securities?
In return for finance provided by an investor, the company issues a security acknowledging the rights of the investor
- Security (piece of paper) acknowledges the debt - this can be kept/sold on
- At maturity date the value of the security will be paid to the holder
E.g. a bond - pays value of bond to holder at maturity and pays interest at particular periods - traded on the capital market
Why are convertible bonds and preference shares considered ‘debt/equity hybrids’?
Convertible bonds - bonds (debt) can be converted into shares (equity)
Preference shares - may have fixed maturity date on which company redeems/purchases share (looks like a debt)
What is a term sheet?
Debt finance document
A statement of key terms of a transaction - amount, interest rate, fees to be paid, events of default etc.
Equivalent to heads of terms
Not legally binding
What is a loan agreement?
Debt finance document
Sets out main commercial terms of a loan (amount, interest, dates on which interest paid, date principal repaid, fees due) - heavily negotiated
Most of information from term sheet but more detail
What might ‘debenture’ refer to?
- Any form of debt security issued by a company (bonds etc.)
- A type of security document most commonly used in secured loan transactions (sets out details of the security)
What is an event of default?
Breach of representation/undertaking gives bank contractual remedies where breach constitutes an event of default
What is a security?
Temporary ownership, possession or other proprietary interest in an asset to ensure a debt is repaid
Protects creditor in event borrower becomes insolvent
Can improve the priority of a debt
What is a pledge, lien, mortgage and charge?
- Pledge - physical possession and legal title e.g. high value assets
- Lien - physical possession no legal title e.g. mechanic repairing car
- Mortgage - no physical possession but legal title e.g. equity of redemption (creditor has to transfer back once repaid)
- Charge - no physical possession nor legal title e.g. equitable proprietary interest in favour of creditor (also has contractual rights over asset to take possessio back
Until a debt is repaid
What are the features of a fixed charge?
- Borrower can still use in ordinary course of business but cannot dispose/create a charge (creditor controls)
- Once enforceable = creditor has ability to appoint receiver of that asset/exercise power of sale of the asset
Machinery, vehicles
What are the features of a floating charge?
Floats over whole class of circulating assets - security provider free to dispose until crystallisation
What is crystallisation? When will it happen?
Floating charge stops floating and fixes to assets in relevant class owned by security provider at time (effectively becoming a fixed charge)
Crystallisation can occur by operation of law, be triggered by certain events as contractually agreed e.g. breach (inc by reason of insolvency)
What are the disadvantages suffered by a creditor with floating charges?
- Creditor unsure of value of assets until crystallisation
- Ranks below a fixed charge and preferential creditors (subject to a negative pledge clause)
- Floating charges created on/after 15 Sep 2003 are subject to a part of the proceeds of assets being set aside (prescribed part fund for unsecured creditors)
Negative pledge clause = prohibits creation of a later fixed charge; if one is created, floating charge has priority
What is a guarantee?
An agreement that guarantor will pay borrower’s detb if borrower fais to do so
Is not a form of security (but has same effect)
Downstream guarantee = parent is guarantor for subsidiary
Upstream guarantee = subsidiary is guarantor for parent
Cross-stream guarantee = subsidiary is guarantor for another subsidiary
Do charges created by a UK company over assets abroad need to be registered at Companies House?
Yes
For registration of a charge, when does a company/person interested in the charge have to deliver the relevant documents?
Within 21 days - beginning with the day after on which the charge is created
The Registrar registers the charge
What must be included on section 859D statement of particulars?
- Company creating charge
- Date of creation of charge
- Persons entitled to charge
- Short description of any property registerd in UK subject to a fixed charge
What else - other than section 859D - needs to be delivered?
- Certified copy of the charge
- Relevant fee
What does a Registrar allocate and issue once charge is registered?
- Allocates a unique reference code and includes it on register with certified copy of the charge
- Issue a signed/authenticated certificate of registration (conclusive evidence of registered charge)
Who will register the charge?
Either creator or person interested in charge - usually lender’s solicitors (have most to lose)
What happens if the charge is not registered at all or within the 21 day period?
Charge is void and debt becomes immediately payable
Effectively worthless if not registered
What records must be kept available for inspection by a company re charge?
Copy of every charge and every instrument that amends or varies charge
Can be certified copies rather than originals
What are the rules regarding inspection of charge documents?
- Company must inform CH of place where documents are available for inspection
- Must be available for inspection by any creditor or member free of charge and any other person by payment of fee
- If a company refuses inspection, a court may order that company allows immediate inspection
Failure to comply with any above = fine
What is the order of priority between creditors?
Upon winding up
- Creditors with fixed charges
- Preferential creditors
- Creditors with floating charges
- Unsecured creditors
- Shareholders
What if more than one creditor has a fixed/floating charge over the same assets?
The first fixed charge has priority (from when created, not registered)
Can be varied by agreement between creditors (Deed of Priority/Intercreditor Agreement/Subodrination Agreement) - benefit of creditors not having to rely on uncertain and complex priority rules
How do shareholders, unsecured and preferential creditors rank?
Equally amongst themselves within their category (subject to preferential rights)
Does not matter when debt incurred; no one creditor takes priority
What are the general rules for the effect of equity and debt on the balance sheet?
- Equity - both net asset value and total equity change (both halves affected)
- Debt - net asset value of company will not change as a result of loan (but asset + liabilities will) and equity will not change (top half affected)
How is the price of a share calculated?
Value of company as a whole / number of shares in issue
What is a premium?
The amount paid for share over the nominal value
What is the effect on the balance sheet of issuing a share for the same amount as nominal value?
- Increase share capital to show nominal value of shares issued to shareholder
- Increase cash to show cash received by company for shares
Bottom half and top half affected
What is the effect on the balance sheet of issuing a share for more than its nominal value?
For top half
* Increase cash (top half)
For bottom half
* Increase share capital to show nominal amount of new shares
* Increase premium account to show premium amount of new shares
What can the premium account not be used for?
Paying dividends (among other things!)
How is the earnings per share ratio calculated and what does it show?
Profit after tax / average number of ordinary shares in issue whilst profit generated
* Shows return due to ordinary shareholders
Increase in number of shares = dilution of earnings per share
What is the effect on the balance sheet when a company takes out a loan?
- The companies liabilities are increased by the amount of the loan
- The company’s assets (cash) are also increased by the loan funds
Net assets remain unchanged (as does total equity)
What is a company’s gearing (/leverage)?
What is the formula?
The ratio of debt to equity - the higher the ratio the more highly a company is geared
Long term debt (non-current liabilities) / Equity x 100
What does a high level of gearing mean?
The amount of long-term debt loan capital is very high compared to amount of shareholder funds in the company
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What are the risks of a highly geared company?
- Less equity to absorb company losses (and less protection to creditors)
- Will need to make profits before interest and tax to meet demands for interest payments (dangerous in bad economic conditions)
What are the advantages of a highly geared company?
- Can make far bigger investment (with bigger returns) by borrowing money than just using own
- Does not require share dilution through issue of new shares
- Can improve earnings per share (high level of loan capital cf with equity)
