Funding options: debt

Question 1

what are the debt funding options?
Briefly explain each

Answer 1

1. obtain a loan from a bank/building society
2. issue a debt security (essentially an IOU with interest and borrower agrees to repay by maturity date e.g. bonds. Commonly traded on capital markets)

Question 2

what is the position on borrowing under the MAs?

Answer 2

No restriction on borrowing under MAAs (if AAs inc. restrictions the company would need to pass an SR to amend the AAs)

Question 3

what are the different types of loan? (3)

Answer 3

1. overdraft
2. term loan
3. revolving credit facility

Question 4

explain an overdraft and its advantages and disadvantages

Answer 4

allows business go overdrawn into it’s current account.
✔️ = quick and flexible. Good for short term borrowing.
❌ = bank can demand repayment at any time. High interest rates

Question 5

explain a term loan and its advantages and disadvantages

Answer 5

fixed amount borrower that is repaid at the end of a set period of time.
✔️ = interest payable can be reduced if the loan is drawn down in instalments (rather than all at once). Lender can only demand repayment in accordance with the agreement.
❌ = time & expense in negotiating loan terms. Money can’t be re-borrowed once paid.

Question 6

explain a revolving credit facility and its advantages and disadvantages

Answer 6

the bank will make a maximum amount available and the borrower can re-borrow amounts it has already paid.
✔️ = good for businesses with uneven cash flow. Flexible. Can reduce interest by reducing amount borrowed.
❌ = time & expense negotiating terms. Often high charges.

Question 7

what is a committed facility and the key terms (5)? Give two examples

Answer 7

Term loans & RFCs are committed facilities (= legally binding credit agreement between borrower and lender).

Key terms:
o Loan details i.e. amount, currency, type
o Repayment i.e. in full at the end of the term? Equal instalments throughout?
o Interest rates i.e. agreed, fixed or variable
o Covenants i.e. borrower to pay debts as they fall due
o Events of default i.e. lender can terminate, commence insolvency etc

Question 8

what are the advantages of debt finance? (5)

Answer 8

• Generally, interest payable on the debt is tax deductible from profits.
• Lender will not have any ownership/influence over the company
• Once the debt is repaid, obligations to the lender end
• Loans and generally quicker to obtain than equity funding
• No risk of company politics

Question 9

what are the disadvantages of debt finance? (6)

Answer 9

• Interest payable on the loan (but can be tax deductible)
• Interest payments are a contractual liability and so must be paid before dividends (this is particularly relevant if the business has cash flow issues)
• The creditor may require security for the loan
• Agreement may restrict the company from taking out further debt
• Loan capital must be repaid
• Lender could sell the debenture to a third party