debt financing

Equity

flexible in timing and amount, decided upon by the management of the firm

Debt

Contractual obligations agreed upon in advance

Senority

Must make debt payments before investment or equity paymenet

Missing a debt payment has serious repercussions

Decision making

Management works on behalf of the equity owners

Debt doesn’t get a say

Debt Contracts

Specifies

1. Amount

2. Schedule of repayments

3. Repayment amount

4. Additional features

Types of debt

Loan, debt security

Term Loan

Loans w fixed terms/ repayment dates 

Revolving line of credit

Commitment from the bank that allows the firm up to a specified amount, as needed

Syndicated Loan

Term loan offered by group of banks

Debt securities (bonds/ commercial paper)

Debt obligations sold by firm to investors 

Can be public/ private

Predetermined coupon and principal

Debt Management

Refers to determining a schedule of debt issuance/ payments that meet the needs of the firm

Managing maturity

Maintaining long term debt with payments that are spread over time to avoid roll-over risk

Requires issuing moderate amounts of debt regularly to maintain a stable structure of payments

Trade off: Managing yield

In some years, interest rates are low

Firm can take advantage through issuing a lot of debt

Three Main credit rating agencies

Moody’s, S&P, Fitch

Determining Credit Grade

Combine info of the performance of the firm (debt/ edbitda) and the industry

Senority

Senority determines which creditors are paid first in bankruptcy

Firms can sell debt with different levels of senority

Covenants

Restrictive clauses in a debt contract that limit the borrower from taking action that may hurt the creditors

Bond Covenants

Prevents “bad” actions

Hard to renegotiate

Bank loan covenants

Designed to trip in bad times

Easier to renegotiate

Callable Bonds 

Allow the borrow to repay early

All else equal, this is good for the borrower 

Call Date

The date at which early repaymenet can occur

Call Price

Price at which borrower can repay (percentage of face value)

Convertible bonds

Give creditors the right to exchange the bonds for equity 

Conversion price

The share price at which the fv of the debt is = to the value of the converted shares

All else equal, this clause is good for the creditor (get more money than they put in)