Company Finance – DEBT
“gearing” = ratio of borrowings to shareholder funds
High gearing = greater burden of borrowings and the greater possibility of insolvency if trading
conditions worsen
Preliminaries:
Company must be able to borrow money: a company will usually have an implied power to
borrow money, unless expressly excluded by placing a restriction in the company’s articles – if
company is a 1985 company, or has amended or bespoke articles, need to check for any
limitations
o If there are any restrictions, company’s shareholders must pass a special resolution
under s.21 to amend the articles
o Private company is able to borrow money from the moment its certificate of
incorporation is issued
Directors must have the authority to act on behalf of the company and borrow money
o Art.3 MAs, or art.70 Table A for 1985 companies
o If company has amended or bespoke articles, must check them to see if shareholders’
approval is required for borrowing over a certain level
Two types of debt finance:
Loans = company borrows money from banks (or other lenders, e.g. directors or shareholders)
o General:
Terms will be negotiated and will be agreed on the basis of usual market
practice, the purpose and length of the loan, the background and finances of the
company, the relative bargaining power of the parties (company usually in
weaker position), and general economic conditions
Security is usually required
If not, a higher interest rate is usually payable (risk for lender is higher)
Agreement is governed by contract law
o Types of loans:
Overdraft DEF – contract between the company and its bank which
allows the company to go overdrawn on its current account
Temporary loan used to cover everyday business
expenses when there is no other source of money
available
Maximum amount is agreed with bank
Company must pay a fee + interest at bank’s base
rate (compound basis: any unpaid interest is added
to the capital and interest is charged on the total
amount)
o This practice is implied into the contract,
unless otherwise agreed
, ‘uncommitted’ facility = usually payable on demand: at any
time, bank may demand that the overdraft be repaid by the
company immediately, without notice
‘on demand’ = borrower is given enough time to
effect the mechanics of payment, but not enough
time to go and raise the money
o Bank usually won’t demand payment unless
company is in financial difficulty
If security is taken over an existing overdraft account, the
money paid into the overdraft account is treated as
discharging the debt incurred first unless parties agree
otherwise
Security may be held to be invalid if it’s in respect of
monies advanced to the borrower before the
security was put in place
Advantage:
Flexible source of finance
Relatively few formalities are required to arrange
Disadvantages:
May be called in at any time by the bank
Relatively expensive way to borrow, as it’s usually
unsecured
Term loan DEF – company borrows a fixed amount of money for a
specified period, at the end of which it all must be repaid
Loan Usually used to purchase capital asset (land,
agreement, building, machinery)
credit Interest
agreement, or Terms:
facility o Short-term: up to one year
agreement o Medium-term: one to five years
o Long-term: more than five years
Company may be allowed to draw down (take out)
the loan all in one go, or take it in instalments (latter
option reduces interest payments)
o Usually loan is available to the borrower
only for a short period of time (‘availability
period’) and will not be available thereafter
even if company hasn’t borrowed the full
amount
Can be secured or unsecured (usually secured)
Bilateral = loan is between company and lender
Syndicated = between company and a number of different
lenders who jointly provide the money
, Used where the loan amount is high, and risk of
lending to the company is shared between a
number of lenders
Advantages:
Gives greater certainty than an overdraft (which is
on demand)
Disadvantages:
Time and expense in negotiating and agreeing all
the legal documentation for such a loan
Once repaid, the money cannot then be reborrowed
by the company
Revolving DEF – bank makes available a maximum amount of money
credit facility to the company throughout the agreed period of the
facility, and company can borrow and repay amounts during
Facility the lifetime of the facility (can reborrow amounts that it has
agreement already repaid, so long as it doesn’t exceed the overall
maximum figure)
Company doesn’t necessarily have to take up the
whole amount
Useful for companies whose income isn’t evenly
distributed throughout the year
Interest
Can be secured or unsecured (usually secured) and can be
bilateral, or syndicated
Advantages:
Very flexible means of borrowing money
Possible to reduce total amount of interest payable
by reducing borrowings
Disadvantages:
Time and expense of negotiating and agreeing all
the legal documentation
Higher fees
o Common contractual terms within a term loan and a revolving credit facility:
Payment of money to borrower
Amount of loan, currency, type of loan, availability period during which
loan can be taken (for RCF, this is almost the entire length of the facility)
‘committed’ facilities – once loan agreement is signed, bank must
provide the company with the loan monies when it requests them
o Commitment fee is payable by the company
If lender refuses to lend in breach of agreement, company is entitled to
damages
“gearing” = ratio of borrowings to shareholder funds
High gearing = greater burden of borrowings and the greater possibility of insolvency if trading
conditions worsen
Preliminaries:
Company must be able to borrow money: a company will usually have an implied power to
borrow money, unless expressly excluded by placing a restriction in the company’s articles – if
company is a 1985 company, or has amended or bespoke articles, need to check for any
limitations
o If there are any restrictions, company’s shareholders must pass a special resolution
under s.21 to amend the articles
o Private company is able to borrow money from the moment its certificate of
incorporation is issued
Directors must have the authority to act on behalf of the company and borrow money
o Art.3 MAs, or art.70 Table A for 1985 companies
o If company has amended or bespoke articles, must check them to see if shareholders’
approval is required for borrowing over a certain level
Two types of debt finance:
Loans = company borrows money from banks (or other lenders, e.g. directors or shareholders)
o General:
Terms will be negotiated and will be agreed on the basis of usual market
practice, the purpose and length of the loan, the background and finances of the
company, the relative bargaining power of the parties (company usually in
weaker position), and general economic conditions
Security is usually required
If not, a higher interest rate is usually payable (risk for lender is higher)
Agreement is governed by contract law
o Types of loans:
Overdraft DEF – contract between the company and its bank which
allows the company to go overdrawn on its current account
Temporary loan used to cover everyday business
expenses when there is no other source of money
available
Maximum amount is agreed with bank
Company must pay a fee + interest at bank’s base
rate (compound basis: any unpaid interest is added
to the capital and interest is charged on the total
amount)
o This practice is implied into the contract,
unless otherwise agreed
, ‘uncommitted’ facility = usually payable on demand: at any
time, bank may demand that the overdraft be repaid by the
company immediately, without notice
‘on demand’ = borrower is given enough time to
effect the mechanics of payment, but not enough
time to go and raise the money
o Bank usually won’t demand payment unless
company is in financial difficulty
If security is taken over an existing overdraft account, the
money paid into the overdraft account is treated as
discharging the debt incurred first unless parties agree
otherwise
Security may be held to be invalid if it’s in respect of
monies advanced to the borrower before the
security was put in place
Advantage:
Flexible source of finance
Relatively few formalities are required to arrange
Disadvantages:
May be called in at any time by the bank
Relatively expensive way to borrow, as it’s usually
unsecured
Term loan DEF – company borrows a fixed amount of money for a
specified period, at the end of which it all must be repaid
Loan Usually used to purchase capital asset (land,
agreement, building, machinery)
credit Interest
agreement, or Terms:
facility o Short-term: up to one year
agreement o Medium-term: one to five years
o Long-term: more than five years
Company may be allowed to draw down (take out)
the loan all in one go, or take it in instalments (latter
option reduces interest payments)
o Usually loan is available to the borrower
only for a short period of time (‘availability
period’) and will not be available thereafter
even if company hasn’t borrowed the full
amount
Can be secured or unsecured (usually secured)
Bilateral = loan is between company and lender
Syndicated = between company and a number of different
lenders who jointly provide the money
, Used where the loan amount is high, and risk of
lending to the company is shared between a
number of lenders
Advantages:
Gives greater certainty than an overdraft (which is
on demand)
Disadvantages:
Time and expense in negotiating and agreeing all
the legal documentation for such a loan
Once repaid, the money cannot then be reborrowed
by the company
Revolving DEF – bank makes available a maximum amount of money
credit facility to the company throughout the agreed period of the
facility, and company can borrow and repay amounts during
Facility the lifetime of the facility (can reborrow amounts that it has
agreement already repaid, so long as it doesn’t exceed the overall
maximum figure)
Company doesn’t necessarily have to take up the
whole amount
Useful for companies whose income isn’t evenly
distributed throughout the year
Interest
Can be secured or unsecured (usually secured) and can be
bilateral, or syndicated
Advantages:
Very flexible means of borrowing money
Possible to reduce total amount of interest payable
by reducing borrowings
Disadvantages:
Time and expense of negotiating and agreeing all
the legal documentation
Higher fees
o Common contractual terms within a term loan and a revolving credit facility:
Payment of money to borrower
Amount of loan, currency, type of loan, availability period during which
loan can be taken (for RCF, this is almost the entire length of the facility)
‘committed’ facilities – once loan agreement is signed, bank must
provide the company with the loan monies when it requests them
o Commitment fee is payable by the company
If lender refuses to lend in breach of agreement, company is entitled to
damages
