Methods of raising debt finance: a quick guide
A quick guide to the different methods of raising debt finance and a comparison of the advantages of two common methods - issuing debt securities and borrowing in the syndicated loan market.
This is one of a series of quick guides, see Quick guides
Why is debt finance important to companies ?
A company may need money for a number of reasons. It may need working capital to pay suppliers, wages or bills; funds for a particular project or transaction, or a one-off sum of money to solve a financial crisis. Most companies raise finance through a combination of equity finance and debt finance. This note looks at debt finance.
What is debt finance?
It primarily means borrowing by bank loan or issuing debt securities
Debt finance consists of raising money by borrowing from a lender, with a promise to repay the money (usually with interest) at a later date. The appropriate method of debt finance will depend on the size and creditworthiness of the borrower and the amount of money required. Debt finance can broadly be divided into two main types:
Issuing debt securities.
Taking out a bank loan.
Other more specialised forms of debt finance include vendor finance and securitisation.
A debt security ( www.practicallaw.com/0-207-6955) is a financial instrument that, in simple terms, is like an IOU. An issuer of debt securities promises to repay the investors the amount borrowed on or by a specified date (which is when a debt security is said to "mature"), usually with interest. Like equity securities, they can usually be easily traded between investors. This feature can make them attractive to investors. Debt securities take many forms, for example:
Bonds (including eurobonds and high yield or junk bonds). These usually have a maturity of one year or more.
Medium term notes. These are debt securities issued under medium term note programmes and usually have a maturity of up to 30 years.
Commercial paper. These are like bonds but have a maturity of less than one year.
A company may get a loan from a single bank (a bilateral loan) or a group of banks (a syndicated loan).
Bank loans are tailored to the borrower's particular needs and so take many forms, for example:
Overdraft (the amount borrowed is repayable on demand).
Term loan (the loan is repayable by the end of a set time period).
Revolving facility (the borrower can re-borrow amounts it has already repaid).
Other miscellaneous forms (for example, a swingline ( www.practicallaw.com/1-377-0393) facility or a bill of exchange ( www.practicallaw.com/9-107-6495) ).
For more on bank loans, see Corporate bank loans: a quick guide ( www.practicallaw.com/8-381-1267) .
Advantages of debt securities
Broad investor base. In an issue of debt securities, an issuer can usually access a much wider group of potential investors than a syndicated loan. Depending on demand at the time, this may mean the issuer can pay a more competitive price for borrowing than with a bank loan.
Trading. Debt securities are transferable instruments (often listed on a stock exchange) that can be traded in the international capital markets. An investor can lend money to the issuer but needn't be bound to wait until the maturity date for his repayment because the debt securities can be sold if the investor needs to realise his investment. This may give an issuer access to willing lenders when a bank loan might not be possible or desirable.
Covenants. The terms and conditions of issues of debt securities generally contain far fewer and less stringent covenants than in a syndicated loan.
Interest rates. Debt securities usually have more flexible interest rate options for a borrower as debt securities can be fixed rate, floating rate, zero coupon and so on. Syndicated loans usually only have a floating rate of interest.
Security over assets. Debt securities are frequently unsecured, whereas traditionally loans are secured.
Disclosure. In a debt securities issue, information about the issuer is usually limited to information that is publicly available. In a syndicated loan, the lending banks conduct very thorough due diligence on the company. This will mean the borrower disclosing much less information to the lender in a bond issue than for a loan.
Advantages of a syndicated loan
Flexibility as to amount borrowed. A syndicated loan can be tailored to allow the borrower to draw down funds when needed, so can be useful as a contingency fund. In an issue of debt securities, the issuer usually receives the full subscription price (and will be liable for interest payments on the full amount) on the issue date so is not an ideal source of finance if the amount of money needed is uncertain or for contingencies.
Flexibility as to amount repaid. Repayments for a syndicated loan can be in instalments or, if the loan is made on a revolving basis, the borrower can repay and redraw money when required. Issues of debt securities usually provide for one payment on maturity (a "bullet repayment") as well as regular interest payments (although some can be repaid in instalments).
Currency. Some syndicated loans allow a borrower to switch the loan from one currency to another for successive interest periods. In an issue of debt securities, the issuer will usually borrow in the currency specified when the debt securities are issued (although "swaps" can be entered to allow the currency to be swapped).
Publicity. Syndicated loans are private transactions between the borrower and the syndicate of banks. The details of an issue of debt securities will become public if the debt securities are listed on a stock exchange.
Renegotiation of terms. With a syndicated loan, it is usually possible to negotiate with the syndicate of lenders if the borrower finds itself in financial difficulties. With an issue of debt securities, it is unlikely the issuer will even know the identity of the investors. There are also likely to be too many investors to renegotiate the terms and conditions.
Size of borrower. Issuers of debt securities generally need to be established companies with a good credit rating because investors will be more willing to invest in a company with a good credit history and reputation. If the issuer is not of sufficient size and creditworthiness to be acceptable to the debt securities markets, it will not be able to issue debt securities and will probably have to rely on loans from banks.
For multi-jurisdictional guides to finance and capital markets, including issues relating to the raising of debt finance, see: