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DEBT FINANCE - Coggle Diagram
DEBT FINANCE
SECURITY
Temporary ownership / possession / proprietary interest in an asset to ensure that a debt is repaid
1. Pledge
Security provider (borrower) gives possession of the asset to creditor until the debt is paid back.
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3. Mortgage
Security provider retains possession of asset but transfers ownership to the creditor subject to the security provider’s right to require the creditor to transfer the asset back to it when the debt is repaid = equity of redemption
4. Charge
Security provider retains possession of asset + creates equitable proprietary interest and contractual rights in the asset in favour of the creditor
a.Fixed charges
- Taken over assets such as machinery and vehicles.
- Creditor controls what security provider can do with assets as security provider undertakes not to dispose of / create further charges without the creditor’s consent.
If the charge becomes enforceable (debt not paid) = creditor can sell / give away asset
b. Floating chargesFloats over the whole of a class of circulating assets so security provider can dispose of the assets until crystallisation = when it stops floating and fixes to the assets in the relevant class so creditor acquires control of them - may occur by law or triggered by certain eventsUSED if not practical for a security provider to undertake not to dispose of its assetsDisadvantages of the floating charge
- Creditor will not be sure of value of secured assets as security provider has freedom to dispose of them
- On winding up = floating charge creditors are below fixed and preference creditors in payment order BUT if floating charge prohibits creation of a later fixed charge + company created one, the floating charge will have priority if the later fixed charge holder had notice of this restriction
- Created on or after 2003 are subject to a part of the proceeds of the assets being set aside = prescribed part fund
5. Guarantees
Not security as do not give rights in assets.
A guarantee for a loan = agreement that guarantor will pay borrower’s debt if the borrower fails to do so.
Guarantees can come from companies / individuals
Registration of security
Company / person interested in charge delivers docs to CH (electronically / paper) w/in 21 days beginning with the day after the day on which the charge is createdDocs - Form MR01 detailing:
- company
- date of creation of the charge
- persons entitled to the charge
- land subject to fixed charge
- certified copy of the charge
- relevant fee
Registrar of Companies provides unique code and issues signed registration certificateEffect of failure to register w/in 21 days =
- charge is void against a liquidator, administrator and any creditor of the company AND
- the debt is immediately payable
Company must keep available for inspection a copy of every charge + amendment at registered office / other permitted place + inform CH where they are
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There are 2 types:
Loan facilities or Debt securities
- A lender will take security over the assets of the borrowing company in case company is unable to repay loan
1. Loan facilities
Agreement between borrower and lender which gives the borrower the right to borrow money on the terms set out in the agreement
b. Overdraft: on-demand = bank can call for all the money owed to it at any point + demand that it is repaid immediately.
Unsuitable as a long-term borrowing facility + interest must be paid on overdrawn amount
a. Term loan: loan for a fixed period of time, repayable on a certain date + lender cannot demand early repayment unless the borrower is in breach of the agreement.
Lender will receive interest on the loan throughout the period.
c. Revolving credit facility: loan for specified period of time + borrower can repeatedly borrow and re-pay loans up to the agreed MAX amount
2. Debt securitiesInvestor provides finance + company issues security acknowledging the investor's rights
- At the maturity date of the security, the company pays the value of the security back to the holder (e.g. bond value is paid to investor)
Debt/equity hybrids
Convertible bonds
- Bonds convertible into shares by issuer in return for agreement to give up right to receive interest and repayment of the principal amount invested.
Preference shares
- Holder of one has no voting rights + will get a definite amount of dividend ahead of other shareholders
If the preference share has a fixed maturity date = debt. IF NOT = equity
Debentures
2 meanings:
- Form of debt security issued by a company, including bonds, whether or not constituting a charge on the assets of the company
- Type of security document sent to Companies House for registration purposes.
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GEARING
Ratio of debt to equity = amount of long-term capital compared to shareholder funds
Gearing is calculated by the formula:
Long term debt (Non-current liabilities) x 100% / Equity (Total Equity)
Risks
- Highly geared companies are credit risk to banks as they have less equity to protect the creditors SO difficult to raise further loans in the future
- Highly geared company will need to make more profits before interest and tax (PBIT) in order to meet the demands for interest payments
Advantages
- Advantageous to shareholders as raising money through debt finance does not require share dilution through the issue of new shares
- Borrowing money allows for bigger investment than company could have made if it was just using its own resources
- High level of loan capital compared to equity in the higher geared company improves the earnings per share of the shareholders BUT in bad time works in reverse