Debt Finance Flashcards
What should you check in assessing a companies ability to borrow?
- when the company was incorporated
- company’s articles
What is a loan facility?
An agreement between a borrower and a lender which gives the borrower the right to borrow money on the terms set out in the agreement
What is an overdraft?
On-demand facility - bank can call in debt at anytime and demand immediate repayment
What is a term loan? What are its key features?
Loan of money for fixed period of time, repayable on a certain date.
Lender cannot demand early repayment unless borrower breaches agreement
What is a bullet repayment?
A term loan that is repayable in a single lump sum at the end of the agreement
What is amortising repayment?
A term loan that is repayable in instalments
What is a revolving credit facility?
- Loan for specified period of time
- Borrower can repeatedly borrow and repay loans up to agreed maximum overall amount
What is a debt security?
Company issues a security acknowledging investor’s rights in return for finance provided by an investor
That security can then be sold on by investor
Class example is a bond
How are private companies restricted in their issue of bonds?
Can only issue to targeted investors and not the public indiscriminately
What are convertible bonds? What happens if they are converted?
Bonds which can be converted into shares in the issuing company.
If bondholder chooses to convert they receive shares but lose right to receive interest and repayment of principal amount invested
What is a term sheet in debt financing?
- Statement of key terms of transaction agreed by lender and borrower.
- Equivalent to heads of terms.
- Not intended to be legally binding
What is a loan agreement?
- Document that sets out the main commercial terms of the loan agreement such as interest, interest dates, date principal loan will be repaid, fees etc
- Intended to be legally binding
What are the two meanings of debenture?
- s 738 - debenture means any form of debt security issued by a company, include debenture stock, bonds, and other securities of a company whether or not constituting a charge on company assets
- type of security document and one of the most commonly used in secured loan transactions. Separate document from loan agreement setting out details of security. Debenture sent for registration purposes at Companies House
What are representations in loan agreements?
Statements of fact as to legal and commercial matters made on signing of the loan agreement and repeated periodically during the life of the loan
What are undertakings in loan agreements?
Undertakings are promises to do (or not to do something or to procure that something is done or not done
What is Event of Default clause?
Clause that gives bank power to call in its money early if borrower shows signs of becoming an enhanced credit risk
What is a pledge?
Security provider gives possession of the asset to the creditor until the debt is paid back eg pawning a watch
What is a lien?
Creditor retains possession of asset until debt is paid back eg mechanic’s lien
What is a mortgage?
Security provider retains possession of the asset but transfers ownerships to the creditor
Security provider will then have ownership transferred back to them when the debt is repaid - right of equity of redemption
What is a charge?
Security provider retains possession but subject to equitable proprietary interest in the asset in favour of the creditor
Lender will also take certain contractual rights over the assets such as right to sell or receiver/administrator to take possession if debt not paid back
What is a fixed charge?
A fixed charge is normally taken over assets such as machinery and vehicles.
Creditor can control what the security provider can do with the fixed charge assets but borrower can still use it.
Security provider undertakes not to dispose of or create further charges over the charged assets without the creditor’s consent
What happens when a fixed charge becomes enforceable?
Creditor will have the ability to appoint a receiver of that asset or to exercise a power of sale of the asset
What is a floating charge?
A floating charge floats over the whole of a class of circulating/fluctuating assets.
Whatever assets in that class happen to be owned by the security provider of any given time are subject to the floating charge and the security provider is free to dispose of the assets as it wishes until crystallisation
What happens on crystallisation of a floating charge?
Floating charge stops floating and fixes to the assets in the relevant class which are owned by the security provider at the time of crystallisation
Creditor thus acquires control over the assets as if they had a fixed charge over them.
When will crystallisation occur?
Either by operation of law or may be triggered by certain events as contractually agreed.
Usually triggered by breach of significant loan terms
What are the disadvantages of a floating charge from the creditor’s perspective?
- provider free to use and dispose of the assets
- floating charge ranks below fixed charge holders and preferential creditors in insolvency/winding up
- on or after 15 September 2003 floating charges are subject to prescribed part for unsecured creditors
- possible for them to be avoided under s 245 insolvency act 1986
- administrator free to deal with floating charge assets in their control without reference to floating charge holder or the court and pay their remuneration and expenses out of proceeds of those assets
Where must most security charges for companies be registered?
Companies House
When must a security be registered at Companies House?
Within 21 days beginning with the day after the charge is created
What must be sent to Companies House for a charge to be registered?
(i) section 859D statement of particulars set out on Form MR01 detailing:
- the company creating the charge
- the date of creation of the charge
- the persons entitled to the charge
- a short description of any land, ships, aircraft or intellectual property registered (or required to be registered) in the UK which is subject to a fixed charge
(ii) a certified copy of the charge
(iii) the relevant fee
What happens on registration?
- the registrar allocates the charge a unique reference code includes it on the register with certified copy of the charge
- registrar must issue a signed/authenticated certificate of registration
Who can register a charge at Companies House?
- either company creating the charge or
- any person interested in that charge
What happens if the charge is not registered?
- the charge is void against any liquidator, administrator and any creditor of the company and
- the debt becomes payable immediately
What records of registration of the charge must a company keep and where?
Must keep copy of every charge (and any variations) available for inspection at company’s registered office
Who may inspect copies of charge at company’s registered office?
- creditor or member of company for free of charge
- member of public on payment of prescribed fee
What is the order of priority between creditors?
1) creditors with fixed charge
2) preferential creditors - employee wages (£800 per employee), occupation pensions, sums owed to HMRC
3) creditors with floating charges (less prescribed part for secured creditors)
4) unsecured creditors
5) shareholders
What is the priority among secured creditors?
If more than one security holder in the one class, priority by time charge created
Earlier in time, stronger in right
Can be varied by agreement between the creditors through Deed of Priority, an inter creditor agreement or a subordination agreement
How do shareholders, unsecured and preferential creditors rank in their own class?
Equally
What effect will equity finance have on the balance sheet?
The net asset value of company and total equity will rise
What effect will debt finance have on the balance sheet?
The net asset value of the company will not change as a result of the loan nor will the equity of the company
What will happen if shares are issued for more than their nominal value on the balance sheet?
Separate share premium account will be created for the premium paid above normal share capital
What is earnings per share?
Shows return due to ordinary shareholders
How is earnings per share calculated?
Dividing profit after tax by the average number of ordinary shares in issue whilst the profit was generated
What is debt’s finance effect on the balance sheet?
- company’s liabilities are increased by the amount of the loan
- company’s current assets are also increased by loan funds
Net assets however remain the same
What is gearing?
Ratio debt to equity
(Ratio of liabilities to shareholder funds)
Higher the ratio of debt to equity, the more highly geared a company is
How is gearing calculated?
Long term debt (non current liabilities)/ equity (total equity) x 100%
What are the risks of being highly geared?
- seen as more of a credit risk by banks and other lenders, so less likely to get more loans in the future
- less equity to protect creditors
- will have to pay more in interest
What are the advantages of being highly geared?
- borrowing money, company can make a bigger investment than it could have by just using own resources
- increasing gearing may be more advantageous to shareholder because raising money through debt finance does not require share dilution through the issue of new shares
