Corporate loan facilities: a quick guide

A quick guide to some of the common types of loan available to a company and to some of the points to bear in mind when negotiating a loan. This guide is aimed at those who have little or no experience of corporate loans.

This is one of a series of quick guides, see Quick guides.

This quick guide also links to a multi-jurisdictional guide to finance and a detailed note on corporate loan facilities in the United States.

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 the 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.

Overdraft

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 (which may be a bank or other financial institution) has discretion whether to lend, even after the overdraft facility agreement has been executed. They are usually repayable on demand, making them unsuitable for certain purposes, such as funding a major acquisition. The lender will not generally 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:

• Lack of certainty about whether the lender will lend and when the lender will demand repayment.
• Lender charges may be high.
• The lender usually uses its standard form document so the borrower has little scope for amendment.
• Only a limited amount may be borrowed.
• The borrower may have 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).

Term loan facility

A term loan facility:

• Provides an agreed 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 (in equal amounts) is spread evenly over the term of the loan facility;
  • balloon repayment: repayment is made in instalments and the final instalment is the biggest; and
  • bullet repayment: repayment is made in a single instalment at the expiry of the loan facility.
• Is a committed facility. The lender must advance money when asked to by the borrower (subject to the borrower complying with certain conditions) once the loan agreement has been executed. The lender usually charges a commitment fee.
• Usually allows the borrower to draw down (borrow) the 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 loan before the dates specified in the repayment schedule. Although there may be a prepayment fee, the borrower will save on interest.

The advantages of a term loan facility are that the borrower can control the amount of its borrowing and therefore how much interest it pays. It also has certainty of funds and a 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 re-borrowed. 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 an interest period, the borrower will decide whether to repay or "rollover" the advance into a new interest period. Rolling over an advance means the advance 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 at any time, and repay outstanding advances that are no longer required. The disadvantages are that commitment fees may be high. There may also be restrictions such as minimum notice periods before an advance is made, or limits on the amount 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, revolving credit and overdraft facilities.

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 (for example, for regulatory reasons) to lend the whole amount.

Comparison between a bilateral loan and a 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 ongoing confidentiality 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 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 (the loan would probably be refinanced instead). In contrast, 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 (and in acquisition financing, the target itself) as well as any material subsidiaries. Security may attach to certain or all of the assets of the security providers. When granting security, the borrower should check for each security provider:

• The security document does not prohibit the security provider from carrying out any planned activities, in particular its day-to-day business.
• Whether an existing negative pledge (www.practicallaw.com/2-107-6875) 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 prohibition 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 prohibition continues to apply to public companies. For more information, see Practice notes, Financial assistance: Companies Act 2006 (www.practicallaw.com/2-202-4475) and Financial assistance: 1 October 2009 (www.practicallaw.com/8-382-5504).

Potential headaches

Most lenders base their loan documents on the Loan Market Association's (www.practicallaw.com/6-107-6779) (LMA) standard forms and expect many of the LMA clauses to be treated as market standard. Nonetheless, the borrower's key objectives 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.
• Ensure that the lender's attempts to monitor the borrower's activities (for example, in the covenants (www.practicallaw.com/8-107-6009) and events of default (www.practicallaw.com/9-107-6565)) do not interfere with the borrower's ability to run its business.
• Moderate its obligations with reasonableness and materiality thresholds.
• Ensure certainty by including objective, not subjective, tests.
• Increase flexibility with grace periods and mitigation clauses before events of default are triggered.
• Allow decisions 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.