Workshop 8: Debt Finance Flashcards
What are the names of the two main types of debt finance?
- Debt securities
- Loan facilities
What is the difference between ‘debt security’ and ‘security for a debt’?
Debt security - a type of debt
Security for a debt - something the lender will take over the assets of the borrow to protect the lender’s interests
What are the three main types of ‘loan facilities’?
- Overdraft
- Term loan
- Revolving credit facility
What is a ‘loan facility’?
An agreement between a borrower and a lender which gives the borrower the right to borrow money based on agreement terms
Why is an ‘overdraft’ unsuitable for long-term borrowing?
Because the bank can call for all of the money owed at any time - and demand it is repaid immediately
What is a ‘term loan’?
A loan of money for a fixed period, repayable on a certain date
What is the name of the term when a ‘term loan’ is repaid in instalments?
‘Amortising’
What is ‘revolving credit facility’?
How is it different to a ‘term loan’?
A loan of money for a fixed period
The borrower can repeatedly borrow and re-pay loans up to agreed max
What’s beneficial about ‘revolving credit facility’?
What is it a ‘hybrid’ between?
The borrow can keep interest payments down
It’s like a hybrid between overdrafts and term loans
What part of the money is interest paid on for ‘overdrafts’?
It is paid on the amount that the customer is ‘overdrawn’
What are the interest arrangements for ‘term loans’?
Interest is received on the loan throughout the period
How is interest kept down with ‘revolving credit facility’?
The borrow can keep interest payments down, by borrowing only when it needs the funds
How are ‘debt securities’ defined?
An investor’s provision of finance in exchange for the company’s issue of a ‘security’ which acknowledges the investor’s rights
What is a classic example of ‘debt security’?
A bond
What is a ‘bond’?
It is a ‘debt security’ where the issue (company) promises to pay the bond value to the holder of the bond at maturity
Who receives the value of the bond at maturity from the issuer?
The holder of the bond at the time of maturity
Can a bond be kept or sold/traded?
Yes - they are issued with the view of being traded
Who can private companies issue bonds to?
Who can private companies not issue bonds to?
They can issue them to targeted investors
They cannot issue them to the public indiscriminately
How do ‘convertible bonds’ work?
Debt security - bonds - that are converted into equity security - shares (bond is swapped for the share)
What is the ‘convertible bond’ swap?
The issuer converts/swaps the bonds to shares, in return for the holder’s agreement to give its interests and repayment of the principal amount invested
Why does a ‘preference share’ look like a debt/equity hybrid?
Because a preference share holder may have a fixed maturity ate, meaning the company must redeem or purchase it at that time
What are the three main debt finance documents called?
- Term sheet
- Loan agreement
- Security document
What is a ‘term sheet’ equivalent to?
A ‘heads of terms’ - it is not intended to be legally binding but, rather states the understanding of the parties’ agreement on the transaction
What does a ‘loan agreement’ do?
Sets out main commercial terms of the loan including
- Amount of interest
- Dates where interest will be paid
- Dates where principal will need to be paid
- Due fees
When does the ‘security document’ come into play?
When a loan is secured, this will be negotiated and entered into
What are the two meanings of a ‘debenture’?
- s 738 CA 2006 - covers any form of debt security issues by a company
- A type of security document, most common in secured loan transaction
What does a ‘debenture’ do?
Are there any filing requirements?
This sets out the details of the security
It must be sent to CH for registration purposes
What is a ‘representation’ in a loan agreement?
Statements of fact as to legal and commercial matters made on signing of loans agreement
They are repeated periodically during the life of the loan
What is an ‘undertaking’ in a loan agreement?
Promises to do or not to do something
Or
To procure that something is done or not done
What is an ‘event of default’ in a loan agreement?
Given rise to when a breach of represenataion or undertaking occurs
Why is an ‘event of default’ vital for the bank?
It gives them the power to call their money earlier if the borrower shoes signs of becoming an enhanced credit risk
What are the names of the four main types of ‘security’?
- Pledge
- Lien
- Mortgage
- Charge
What does ‘security’ mean in the context of debt security?
It is known commonly as temporary ownership in an asset to ensure that a debt owed is repaid
What is a ‘pledge’ security?
Where the security provider (usually the borrower) gives possession of the asset to the creditor, until the debt is paid back
What is a ‘lien’ security?
Where the creditor retains possession of the asset until the debt is paid back
What is a ‘mortgage’ security?
Where the security provider (usually the borrower) retains possession of the asset but transfers ownership to the creditor (usually the lender)
What two conditions is the transfer of a mortgage security subject to?
- The creditor’s right to take and sell the asset it if the security provider defaults
- The security provider’s right to require the creditor to transfer the asset back to it when debt is repaid
What is the ‘right to require the creditor to transfer the asset back to it when debt is repaid’ known as?
‘Equity of redemption’
How is a ‘charge’ different from a ‘mortgage’?
Instead of transferring ownership, the ‘charge’ icreates an ‘equitable proprietary interest’ in the asset in favour of the creditor
What does the ‘charging document’ give to the lender?
It gives them some contractual rights over the asset
What are the two types of charges available?
- Floating
- Fixed
What type of assets are ‘fixed charges’ taken over?
- Machinery
- Vehicles
What is the key element of a ‘fixed charge’?
That the creditor can control what the security provider can do with the ‘fixed charge assets’
What is meant by ‘control’ regarding what a borrower can do with ‘fixed charged assets’?
The borrower is restricted regarding its disposal or charge
What must the borrower do if they wish to charge or dispose of the ‘fixed charge asset’?
Obtain consent from the lender
What happens if the ‘fixed charge’ becomes enforcable?
The creditor can appoint a ‘receiver’ of the assert to exercise power of its sale to satisfy unpaid debt
Where are ‘floating charges’ more suitable?
Over assets the borrower requires free disposal of, usually over a ‘class of assets’ e.g., stock
When does ‘crystallisation’ occur?
Usually when the borrower has breached significant terms of loan agreement
What is the meaning of ‘crystallisation’?
When the ‘floating charge’ stops ‘floating’ and becomes fixed to the assets
What is the impact of ‘crystallisation’?
The creditor now acquires control of the assets, and it essentially becomes a ‘fixed charge’
What are two main ‘floating charges’ disadvantages for creditors?
- Assets may have been sold before crystallisation
- Statutory order or priority of payment when company is wound up; ranks below fixed charge
Does crystallisation change where the ‘floating charge’ creditor ranks if a company is wound up?
Nope
Why are ‘guarantees’ not ‘security’?
They do not give rights in assets
What does a ‘guarantee’ for a loan mean?
An agreement that the guarantor will pay the borrowers debt if the borrower fails to do so
Who can provide a ‘guarantee’?
Companies or individuals, like directors
What time frame must charges be registered at CH within?
21 days beginning the day after the day which the charge was created
Do English companies that have assets abroad need to register their charges with CH?
Yes
What are the two mediums a charge can be registered at CH?
Electronically or by paper filing
Who must deliver the charge to CH within the specific time frame?
The one interested in the charger (i.e., the lender)
What’s the name of the document that must be delivered to CH when registering a charge within the specific time frame?
S 859D statement of particulars
What are the two effects of the failure to register the charge within the specified time frame?
- The charge is void against a liquidator, administrator and any creditor of the company
- The debt becomes immediately payable
What must be kept regarding charges by a company?
A company must keep records of every charge and a copy of instruments that amends charges for inspection
Where can a company’s records of charges be kept?
At the company’s registered officer or other locations permitted by the Companies Regulations
TRUE OR FALSE
A company does not need to inform CH where their record of a company’s charges are
False
What is the order of priority of creditors if a company is wound up? There are 5 positions
- Creditors with fixed charges
- Preferential creditors
- Creditors with floating charges
- Unsecured creditors
- Shareholders
Who has priority over assets if two creditors have a ‘fixed/floating charge’ over it?
The creditor that had their ‘fixed/floating charge’ properly registered first
What is the name of the document that can vary the order or priorities of creditors?
‘Deed of Priority’
Which three groups rank equally amongst themselves in the order of priorities when a company is wound up, generally speaking?
Is this subject to anything?
- Shareholders
- Unsecured creditors
- Preferential creditors
This is subject to any preferential rights attached to classes of shares within their respective categories
What is the effect on a company’s ‘Balance Sheet’ if they choose to raise finance by way of equity on the following?:
- Net asset value of the company
- Total equity
Both parts of the ‘Balance Sheet’ will change
So, both halves of the ‘Balance Sheet’ will be affected by the finance
What is the effect on a company’s ‘Balance Sheet’ if they choose to raise finance by way of debt finance on the following?:
- Net asset value of the company
- Total equity
Both parts will not change
So, both halves of the ‘Balance Sheet’ will not be affected by the finance
What two parts of the ‘Balance Sheet’ change when a company issues shares at their ‘nominal value’?
- Increase share capital
- Increase in cash - to show cash received for the shares by the company
What does the ‘top half’ of the ‘Balance Sheet’ show?
What the company owns
What does the ‘bottom half’ of the ‘Balance Sheet’ show?
Where the ‘top half’ [what the company owns] has come from
What changes will be reflected on the top half of the ‘Balance Sheet’ if a company issues shares at a premium?
The ‘cash’ received is increased
What two changes will be reflected on the bottom half of the ‘Balance Sheet’ if a company issues shares at a premium?
- The nominal amount of the new shares is shown by an increase of the ‘share capital’
- The premium is shown by the ‘share premium account’
What purposes can the funds in the ‘share premium account’ be used for?
Limited purposes
What two changes occur to the ‘top half’ of the ‘Balance Sheet’ when a company takes out a loan (debt finance)?
- The company’s liabilities are increase by the loan amount
- The company’s cash are also increased by the load funds
Are the net assets and total equity of a company on their ‘Balance Sheet’ changed when a company takes out a loan?
No
What is a company’s ‘gearing’ or ‘leverage’?
What is ‘gearing’ an important indicator of?
The ration of debt:equity
An important indicator of the financial health of a company
What is the formula to calculate the ‘gearing’ of a company?
Long term debt (Non-current liabilities) / Equity (Total equity) x 100%
What is meant if one was to say ‘a company has a high level of gearing’ of perhaps 75%?
That they have a very high amount of debt [long-term loan capital] compared to amount of total equity [shareholder funds] in company
TRUE OR FALSE
Highly geared companies are not seen of more as a credit risk by bankers and other lenders
False