week 3 Flashcards
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What’s a capital structure?
How a firm finances its operations and growth by using different sources of funds
What do businesses have to pay when they’re borrowing?
They’re obligated to pay the lender interest.
What’s a debenture?
Company-issued document containing an acknowledgement of its indebtedness.
What’s the difference between a secure and unsecured (naked/bare)?
Secured - There’s an asset in security of the loan
Unsecured - No asset on the loan
Name 2 pros of debentures for the borrower (company)
- No voting rights
- No need to ask shareholders to get
- Debentures aren’t subject to capital maintenance
- Can be repaid out of capital
Name the three types of debentures
- Single debentures (one-off)
- Multiple debentures (sequences of singles)
- Series debentures (when you need it)
Name 2 cons of debentures for the borrower (company)
- Interest has to be paid out of pre-tax profits
- Default may lead to liquidation
- High gearing can affect share price
Name 2 pros of debentures for the LENDER
- Debentures rank higher in the event of liquidation so a lower risk option than shares - ask Tim
- Guaranteed interest
- Can have security which reduces risk
Name 2 cons of debentures for the LENDER
- Return is limited to interest payments
- Debentures carry no voting rights
What happens to unsecured creditors in the event of a default?
- Right to sue company for debt
- Right to petition the court for the compulsory liquidation of the company (only if sum is > 750)
- Right to petition the court for an administration order
What happens to secured creditors in the event of a default?
- Take possession of asset
- Seek a foreclosure order
- Appoint a receiver of the assets
- Seek an administration order
What does the word ‘charge’ mean?
Another word for ‘security’ for a debenture.
What’s a fixed charge?
Security over a specific asset which prevents the company from selling the asset without the consent of the creditor.
- Asset must be clearly identified and intended to be retained permanently in the business
- Company has no general freedom to sell the asset
Name 2 pros of a fixed charge
- Immediate and greater security for a loan
- Property cannot be disposed of without lender’s permission
- Fixed Charge ranks higher in priority than floating charges
- Interest rate likely to be lower for the borrowing company due to lower risk for the lender
- Company may find it easier to borrow under a fixed charge due to feeling of greater security
Name 2 cons of fixed charges
- Less freedom to deal with assets for the borrowing company
- Lender at risk if the asset deflates in value or is destroyed
What’s a floating charge?
A security over a class of assets and the company has freedom to buy/sell the charged assets in the ordinary course of its business - charged assets will be subject to changed from time to time.
Which types of firms can floating charges be created by?
Companies and LLPs.
What is crystallisation?
Process by which a floating charge will attach to a specific asset.
Basically, crystallisation turns a floating charge into a fixed charge.
What’re the 3 instances as to when crystallisation occurs?
- Liquidation
- Company ceases to trade
- Any specified event (devaluation)
Name 2 pros of floating charges
- Borrowing firm has freedom to buy/sell the charged assets
- Borrowing firm has greater flexibility over the class of assets that can be charged
- Assets are generally more ‘liquid’ than fixed charged assets
Name 2 cons of floating charges
- Value of security is unknown until it crystallises, the borrowing company cannot be made to make up any loss of value
- Ranks lower in order of repayment than fixed charges on liquidation
- Higher risk so higher interest than fixed charges
What’s the order of distribution?
- Liquidations costs
- Fixed charge holders
- Employees and Secondary Preferential Creditors
- Floating Charge holders
- Unsecured creditors
- Shareholders
What’s priority?
Order that creditors are paid in the event of liquidation.
How do equal charges rank in the event of liquidation?
Rank in order of creation.
