SCL 4 Term Loans

Question 1

Basic principles of long-term lending

Answer 1

• be prepared to offer what the borrower needs, not just what the borrower requests
• you should offer by looking at the cash flows of the company
• Do not offer more than is needed just because it is asked for
• it is risky to provide part of the facilities required by the borrower, because that will compromise the successful execution of the business strategy.
• in those circumstances where you are exceptionally comfortable with the credit risk, on occasion, be prepared to consider lending more than has been requested, if it is needed.
• don’t be afraid to ask for more equity.
• Don’t use short-term facilities for long-term requirements, such as fixed-asset acquisition, the redemption of equity, or a permanent buildup in working capital that is not expected to contract during the life of the facility.
• try to avoid using a short-term line of credit to make long-term debt repayments.
• If a company is in a growth mode, the working capital, particularly the adjusted working capital, is likely to acquire a permanent character.

Question 2

Given the basic principles we just discussed, identify which of the following companies would be the best candidates for a term loan.

Answer 2

Due to their niche audiences and high-risk markets, the clothing outlet and the restaurant would not be the best candidates for term loans. The manufacturer is also catering to a niche audience, but one that is considerably less likely to fail. The best candidate might be the trucking company, which represents the most stable source of income.

Question 3

Purpose of Term Loans

Answer 3

• usually used to purchase noncurrent assets.
• also used to finance a change of ownership or an acquisition
• repay the carryover debt on a seasonal loan or a bridge loan that wasn’t completely repaid
• convert a permanent working capital loan into a loan repaid over time.
• to finance a permanent buildup in working capital that is not expected to contract during the life of the term loan
• used to finance any activity or asset that is accounted for with a useful life greater than one year.
• Payment terms should not only be influenced by cash flow considerations but also with an amortization in concert with the useful life of the asset.

Question 4

For acquisition financing, ensure that

Answer 4

Make sure there is an appropriate contribution of equity financing to the project. Subordinated debt may also be an appropriate complement to the bank’s term loan.

Question 5

Term Loan - Collateral considerations

Answer 5

• the primary security for a term loan is the asset that is being financed
• In some cases, the lender may need to take other collateral (for example land and real estate) as an abundance of caution.
• In some cases, the lender may need to take other collateral (for example land and real estate) as an abundance of caution.
• should be cross-collateralized with all other lending facilities.
• Receivables and inventory can also be taken, but they are usually held as collateral for seasonal loans or permanent capital facilities.