Why is the choice of loan important?
Each type of loan has particular characteristics which suit different purposes, for example, short-term borrowing or finance for a large acquisition. Companies need to make sure that corporate loan they are taking out is suitable for the purpose of the borrowing.
What types of loan are there?
There are various types of loan (or loan facility or credit facility). For example, overdraft, term loan facility and revolving credit facility.
In addition, a loan may be:
- Bilateral or syndicated.
- Secured or unsecured.
An overdraft (or working capital facility) is for solving short-term cash flow problems. It is generally an uncommitted facility. This means that the lender has discretion to lend, even after the bill of exchange agreement has been executed. They can usually be repayable on demand, making them unsuitable for specific purposes, such as funding a major acquisition. The lender will most likely not call in the overdraft unless the borrower’s financial position or activities give it cause for concern.
The advantages of an overdraft are that it is simple and usually available from a company’s existing bank.
The disadvantages are:
- uncertain about whether the lender will lend and when the lender will demand repayment.
- Lender charges may be high.
- The lender usually use of a standard form document so the borrower has little scope for amendment.
- Only a limited amount may be borrowed.
The borrower may need to reduce the overdraft to a specified amount for a particular number of consecutive days from time to time (to ensure it is used only for short-term cash flow problems).
Corporate loan facility
A term loan facility:
- Provides a lump sum over a set period, usually of no more than five years.
- Must be repaid in accordance with a predetermined repayment schedule. The most common methods of structuring a repayment schedule are:
- amortisation: repayment is spread evenly over the term of the corporate loan facility;
- balloon repayment: repayment is made in installments and the final installment is the biggest; and
- bullet repayment: payment that is made in a single installment at the expiry of the corporate loan facility.
- Is a committed facility. The lender must advance money when asked to by the borrower once the loan agreement has been executed.
- Usually allows the borrower to draw down the corporate loan during a short period after the loan agreement has been executed, called an “availability period”.
May allow the borrower to prepay all or part of the corporate loan before the dates specified in the repayment schedule. Although there may be a fee, the borrower will save on interest.
The advantages of a corporate loan facility are that the borrower can control the amount of its borrowing and therefore how much interest it pays. It also has certainty fixed repayment schedule. The disadvantage is that any amount repaid cannot be re-borrowed.
Revolving credit facility
This is a committed facility that provides a maximum amount that can be borrowed over an agreed period. The borrower may draw down and repay advances during the term of the credit facility. Amounts repaid can be borrowed again. The borrower can often select an interest period and fix the interest rate it pays over that period for each advance it draws. At the end of the period, the borrower will decide whether to repay or “rollover” the advance into a new interest period. Rolling over a means the remains outstanding as far as the borrower is concerned. Further advances can be drawn down at any time during the availability period (commonly almost as long as the term of the credit facility) with different interest periods running in parallel.
The advantage of a revolving credit facility is that it is flexible. The borrower can draw down as much or as little money as it requires and repay outstanding advances that are no longer required. The disadvantages are that initial fees are high. There may also be restrictions such as minimum notice periods before progress is made, or limits on the amount of money that may be drawn at any one time.
Bilateral or syndicated
A bilateral loan involves two parties, namely the lender and the borrower. Bilateral facilities are common in the case of small term loan.
In a syndicated loan, two or more lenders each lend a proportion of the money. They are common for larger deals where a lender may not be willing and/or able to lend the whole amount.
Bilateral loan versus syndicated loan
- Documents. The documents for a bilateral loan are simpler than for a syndicated loan.
- Flexibility. A bilateral loan transaction is a private transaction, so the lender may be more flexible on terms than in a syndicated loan where market precedent may need to be followed.
- Confidentiality. Information provided by the borrower for a syndicated loan goes to a number of lenders which increases the risk of leaks, whereas discretion is easier to maintain in a bilateral loan.
- Obtaining consents, waivers and so on. These may be easier to obtain from a single relationship lender, than for a syndicated form of a loan. Where there are a number of lenders who may change over time.
- Fees. These are often less for a bilateral loan than for a syndicated loan, where there may be arrangement or underwriting fees to pay.
- Replacement of lender(s). A bilateral lender is unlikely to transfer its interest to another lender. However, syndicated loan lenders will want to be able to transfer their interests and the borrower may have only a limited right to prevent any such transfer.
Secured or unsecured
Depending on the borrower’s creditworthiness, a lender may require a comprehensive security package from the borrower as well as any material subsidiaries. Security would be attached to certain or all of the assets of the security providers. The borrower should check for each security provider:
- security documents do not prohibit the security providers from carrying out any planned activities, in particular its day-to-day business.
- Whether an existing negative pledge or similar covenant prevents the security provider from granting security.
- In the case of finance for a share purchase, whether the security is prohibited financial assistance. The Companies Act 2006 (2006 Act) changed the law on financial assistance. The ban on a private company giving financial assistance for the acquisition of its own shares (including the whitewash procedure) was repealed by the 2006 Act on 1 October 2008. The ban continues to apply to public companies. For more information, see Practice notes, Financial assistance: Companies Act 2006 and Financial assistance: 1 October 2009.
Most lenders base their corporate loan documents on the Loan Market Association’s (LMA) standard forms and expect many of the LMA clauses to be treated as market standard.
The borrower’s key goal when negotiating the loan will be to:
- Keep expenses to a minimum. The borrower is likely to have to pay the lender’s expenses as well as its own and there may be extra charges that are difficult to quantify
- Moderate its responsibility with reasonableness and materiality thresholds
- Guarantee that the lender’s attempts to monitor the borrower’s activities (for example, in the covenants and events of default) do not interfere with the borrower’s ability to run its business
- Guarantee certainty by including objective, not subjective, tests.
- Increase flexibleness with grace periods and mitigation clauses before events of default are triggered.
- Allow judgment under the syndicated loan documents to be made with the consent of a majority of the lenders to prevent a single bank from having a power of veto.