Debt Finance Flashcards
What is debt finance?
When businesses obtain finance by borrowing money.
What are the different types of debt finance?
Loans and debt securities.
What is a loan?
Where a business borrows money from a bank or another lender, or its directors or shareholders.
What are debt securities?
These are IOUs which a re 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.
What are considerations prior to borrowing in debt finance?
It much check that te company is alowed to, under its constitution.
If the company was formed befoer 2009, and has not updated its articles, you also need to check the company memorandum, to makes sure there are no restrictions on the company borrowing money.
Check there are no restrictions on borrowing money in teh company articles or memorandum. Special resolution needed if so
Directors need authority to act on behalf o the company
What largely governs debt finance?
Contract law
What are 3 types of loans?
Overdraft facility
Term loan
Revolving credit facility
What is an overdraft facility
A contract between the business and its bank, which allows the business to go overdrawn on its currnet account.
Good for every day business expenses.
What are the benefits of overdraft facilities?
Flexible source of finance, and few formalities are required to arrange it.
What are the disadvantages of overdraft facilities?
Repayment may be DEMANDED at any time by the bank.
It is also expensive to borrow, as there are high interest rates in return for offering such flexibility
What are term loans?
Businesses borrow a fixed amount of money (usually from a bank), for a specified period.
At the end of this period, it all must be repaid.
Buyer can pay interest at regulat interals.
What are term loans usually used for?
To purchase a capital asset - such as land, building or machinery
Are term loans secured or unsecured?
Can be either, but they are usually secured
What is a bilateral loan?
Between 2 parties, the business and the bank
What is a syndicated term loan?
Between the business and a NUMBER of different lenders,who JOINTLY provide money the business wants to borrow
What is the contract for a term loan called?
Loan agreement
Credit agreement
Facility agreement
What are the advantages of term loans?
Greater certainty than an overdraft, which is repayable on demand. The borrow also has greater control, because the bank an only request repayment under the terms of the contract
What are the disadvantages of a term loan?
Time and expense in negotiating and agreeing all the legal documentation for such a loan.
Once repaid, the money CANNOT then be re-borrowed by the bank.
What is a revolving credit facility?
The bank agrees t make available a maximum amount of money to the business throughout an agreed period of the revolving credit facility.
The busienss can borrow and repay money during the lifetime of the facility
What is the benefit of revolving credit facilities?
The business is able to reborrow amounts that it has already repaid, so long as it does not exceed the overall max figure.
Very flexible means of borrowing money,and possible to reduce the total amount of interest payable, by reducing borrowings
What are revolving credit facilities usually used for?
For businesses whose income is not evening distributed throughout the year
Seasonal businesses
what are the disadvantages of revolving credit facility?
Time and expense in negotiating and agreeing all the legal documentation for the loan, and high fees that are charged.
What are the initial clauses of the facility agreement, from payment of money to the borrower?
Amount of the loan
Currency
Type of loan availability period during which the loan can be taken.
What does the facility agreement set out about repayment?
Set out agreed repayment schedule for the loan.
May provide repayment of the whole loan (bullet), in equal instalments (amortisation), or unequal instalments (balloon)
What is a bullet repayment?
When repayment is done for the whole loan in ONE GO at the end of the term
What is amortisation repayment
When repayment is in EQUAL instalments over the term of the loan
What is balloon repayment
Repayment is an UNEQUAL instalments, with the FINAL instalment being the LARGEST
What is interest on loans?
Matter of agreement between parties.
No statutory control of interest rate, it iwll be in the facility agreement.
What express covenants may be in the facility agreement of a loan?
Given by the business to the bank
Contractual promise to do or not to do something
Limitation of dividend
Minumum capital requirements
N disposal of assets or change of business
No further security over the assets
Etc
What implied covenants may be in a facility agreement for a loan?
Terms implied into contract.
Trade usage such as the banks right to charge compound interest.
What is the “event of default”
If the business breaches any of the terms in the facility agreement, the lender may terminate the agreement if it wishes to.
what are debentures
Loan agreement in writing, between a borrower and a lender, that is REGISTERED at companies house
It gives the lender security over the borrowers assets.
What is a secured debt?
A lender with security may claim the secured assets of the business if the business fails to meet its obligations under the facility agreement.
If the business becomes insolvent, secured creditors are in a strong ogre position.
Debt finance or equity finance?
More risky investment
Equity
Buying shares is seen as more risky. If the company is in financial difficulties, the shareholder may lose capital value of shares.
Debt finance or equity finance?
Involvement in the company
Equity
Shareholders have certain rights, as owners of the company
A lender is merely a creditor of the company no rights
Debt finance or equity finance?
Repayment of capital
Debt
Loan capital must be repaid at some date in the future, possibly in demand.
Equity : companies do not repay a shareholders capital, UNLESS the company is wound up.
Debt finance or equity finance?
Restrictions on sale
Equity: Transfer of shares is governed by company articles. In private company, these usually restrict shareholders freedoms to sell their shares
Debt: if lender wishes to realise its capital earlier than repayment date, it may sell debenture to third party if ishes
Debt finance or equity finance?
Capital value of investment
Debt
The capital value of facility agreement remains constant, being the value o the loan.
There is usually no possibility of capital appreciation or depreciation with this type of investment.
Debt finance or equity finance?
Payment of income
Equity
Company is ale t pay dividends.
Why grant security on a loan?
If business FAILS to repay loan as agreed, then the lender can SEIZE the secured assets, sell them, and pay itself out of the proceeds of sale
What are the initial considerations when a company borrows money?
Directors must make sure the company has the power to grant security over its assets, before entering into any security contracts on the companys behalf.
If restrictions, special reoslutions needed to change articles
What are the initial considerations for the lender, when a company borrows money?
Lender should make sure there are no restrictions on the company granting SECURITY, and that the directors have authority to act on behalf of the company in the transaction.
What can a lender find out on the register about a company?
Date of creation of any existing chagre
Amount secured
Which property is subject of the chagre
Who holds that charge
What assets may be secured?
Virtually al assets that a company owns may be offered.
Land
Tangible prperty (machinery, computers, stocks)
Intangible property (money in bank account, debts owed, any shares they own in other companies, IP rights)
What are the 3 types of security?
Mortgages
Fixed charges
Floating charges
What is the highest form of security?
Mortgages
When will someone seek security as a mortgage?
High-quality assets owned by the borrower : land, buildings, machinery, aircrafts ships, even shares in other companies.
What does a mortgage consist of?
Involves the transfer of legal ownership from the mortgagor (company) to the mortgagee (lender).
Although the mortgage gives the lender the right to immediately possess the property, this is held in reserve, and exercised only if the borrowed money is not repaid.
What are charges?
Form of security which does not transfer elgal ownership from the chargor to the chargee, and does not give the lender important rights over the asset, should the borrower fal to repay the money borrowed.
What are fixed charges?
May be taken over property such as machinery and shares.
Must create a separate fixed charge over each asset.
The lender has control over the asset. The chariot will not be permitted to dispose of the asset, without the charge holders consent.
If the chargor gets into financial difficulties, they fixed charg holder will haev the right to sell the asset and be paid out of the proceeds of sae.
Is it possible to create more than one fixed charge over the same asset?
Yes. The holder of the fixed charge which was created FIRST will be able to sell the asset, and pay itself out of the proceeds. The remainder can then be given to the second.
What is a floating charge?
Consist of equitable charge over the whole or a class of the companys assets
The assets subject to charge are constantly changing
The company retains the freedom to deal with the asset in the ordinary course of business, until the charge crystallises
Why are floating charges needed for some assets?
If the assets are not suitable for fixed charge, becuase they need to sell them as part of doing business, then floating charge is best.
It secures a group of assets which is constantly changing.
When will a floating charge crystallise?
If the chargor goes into receivership
If the chargor goes into liquidation
If the chargor ceases to trade,
Any other event which occurs which is specified in the charge document
What are book debts?
This is money owed to the company by its debtors.
Suitable for Floating charge
What are the advantages of floating charges?
Allows the chargor to deal with the secured assets on a day-tp-day basis.
As a form of security which can attach to assets unsuited for a fixed charge or mortgage, it allows the chargor to maximise the amount that is able to borrow.
What is a disadvantage of floating charges?
A fixed charge will take priority over a floating charge over the SAME asset.
It allows the charge to deal with the asset. The company could sell its existing stock and not purchase new stock to replace it, meaning the lender does not have charge over anything.
Certain other creditors have the right to claim money from the proceeds fo sale of the assets covered by the floating charge, if the company becomes insolvent.
what are other examples of security
Personal guarantees
A pledge
A lien
Retention of title
What is a personal guarantee ?
Sometimes directors or partners will give a personal guarantee for a loan.
What is a pledge?
This arises where an asset is physically delivered by the debtor to the creditor, to serve as security until the debtor has paid their debt.
What is a lien?
Gives the creditor the right to physical possession of the debtors goods or assets, until the debt is paid.
No right to sell asset
How do you register a charge?
File it at companies house, and a statement of particulars, and a certify copy of instrument creating the charge.
How long do you have to file a security at companies house?
21 days from the creation of the charge
What must the Registrar give to the secured lender?
Must register charge, and include a certified copy of chagre on register. Must give person a certificate of registration, which is CONCLUSIVE evidence that it is property registered.
What happens if the security is not registered at companies house?
Renders the charge VOID against a liquidation or an administrator, and also against the companys other creditors.
The company is SITLL OBLIGED TO PAY BACK, but the lender cannot enforce the security.
What happens if the security is late or inaccurately delivered to the companies house?
21 day period. If issued, or details are inaccurate, the same consequences as if you never registered it.
What is the priority of charges over secured loans?
A fixed charge or mortgage will take priority over a Floating charge over same asset, EVEN if floating charge was created first
If there is MORE than one registered fixed charge or mortgage, they have priority in order of the date of CREATION, NOT their registration
If there is more than one registered floating charge over same asset, they have priority in date of creation, NOT date of registration.
What is a negative pledge?
a floating charge ranks behind a later fixed charge over same asset.
To prevent this, a negative pledge clause can be included in the floating charge documentation.
This clause PROHIBITS the company from creating later chagres with priority to the floating charges< WITHOUT the floating charge holders permission.
What is a deed under s 44 CA?
Company can execute a deed by:
- affixing its seal, or
- By the signatures of: 2 authorised signatures, or a director of the company in prescient of a witness who attests to te signature.
