Debt Finance: A Few Considerations

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This article follows on from the private equity overview write-up and will endeavour to identify the practical considerations surrounding the process, whilst exploring an alternative investment for businesses through the means of debt finance. 

The two most popular methods of raising debt finance for a company are that of loans and debt securities.  A loan is a sum of money paid by a lender to a borrower, who may be a sole trader, in partnership or a company.  Debt securities, on the other hand, are a type of financial instrument, such as a bond, which sets out a promise by the company to pay the holder of the instrument the amount lent on the matured date.

The loans process commences by way of an offer letter from the lender to the borrower.  The letter sets out the structure for the loan agreement, it will include key terms such as the sum of money to be loaned, together with an interest policy and repayment terms.

Once accepted, a loan agreement will need to be entered into between the parties and the agreement will build upon the terms outlined in the offer letter. Importantly, additional clauses will be implemented into the loan agreement and those clauses include provisions such as ‘an event of default’ which allows the lender to call in payment and demand the full amount if certain events occur, such as non-payment or bankruptcy of the borrower.

Separately, the lender may insist on some form of security for advancing the loan.  A common form of security is a charge by means of a debenture. This means that a borrower must create a charge, albeit a fixed charge over any fixed assets and/or a floating charge over non-fixed assets. These charges offer the lender protection so that if a borrower is not able to repay its loan, the advancement made by the lender is secured. This means that the lender can sell the borrower’s assets to recover the sum advanced.

Debt securities, also known as debt covenants, are far less common.  In essence, these are promises given by the borrower to the lender.  These promises also offer protection to the lender as they can feel at ease knowing the business will be managed in such a way as to ensure the advancement can be re-paid.

Unsurprisingly, a key advantage of debt finance, unlike equity finance, is that no equity is given to the lender in return for the loan.  This means the ownership of the business is retained by the business owners.  As such, debt finance is advantageous in that business owners do not forgo any legal ownership of the company.

However, as a borrower, it is important to understand the legal conditions a lender is likely to insist on and to ensure that you as the borrower are aware of all the potential implications of debt finance. It is equally important to be mindful of the lack of flexibility in the loan repayments, as it is common that such repayments are made on the agreed date. On the flip side, and as discussed in last month’s article on private equity, an advantage of raising capital through equity finance is the flexibility in terms of the repayment to the investors. Notwithstanding the flexibility aspect, outside investors can also bring value to the business, as it is common for outside investors to have an interest in other companies thereby sharing knowledge and expertise to aid business growth.

When considering the various loan options to bring in capital for your business, it is important to understand the differences between equity and debt finance, taking into account the advantages and disadvantages of all available options.  In conclusion, you should think about your long term business plan and goals before deciding which form of finance is best suited to the business.

If you want to discuss how best to raise capital for your business please feel free to get in touch with someone from our corporate team who would be happy to assist you. Please contact us at [email protected] or call us on 029 2009 5500 to speak to one of our team.

The information contained in this article is for information purposes only and is not intended to constitute legal advice.