A loan note is a type of debt agreement issued by a company or other entity to raise capital. Loan notes can be secured or unsecured, and they can be issued at a discount or at par.
We often see loan notes being used in corporate transactions, where there is an element of deferred consideration.
In this article, we will discuss what loan notes are, how they work, and some of the most common questions about loan notes.
Is a loan note the same as a loan?
No, a loan note is not the same as a loan, although it is similar.
A loan note is a debt agreement, whereby a loan or loan agreement is a type of credit agreement that is made between a lender and a borrower.
Some of the key differences between loan notes and loans include:
- Maturity period:Loan notes typically have a shorter maturity period than loans. This means that loan notes must be repaid within a shorter period of time.
- Liquidity:Loan notes are not as liquid as loans. This means that it may be more difficult to sell a loan note than it would be to sell a loan.
- Security:Loan notes can be secured or unsecured. Secured loan notes are backed by collateral, such as real estate or equipment. Unsecured loan notes are not backed by collateral.
- Interest:The interest rate on a loan note is typically fixed. The interest rate on a loan can be fixed or variable.
Are loan notes the same as bonds?
Loan notes are similar to bonds, but they typically have a shorter maturity period and are not as liquid. Loan notes can be secured or unsecured, and they typically have a fixed interest rate. Bonds are typically longer-term than loan notes, with a maturity period of 10 years or more. They are also more liquid than loan notes, meaning that they are easier to sell. Bonds can be secured or unsecured, and they can have a fixed or variable interest rate.
In general, loan notes are a good option for companies that need to raise capital for a short-term project or need to finance a working capital need. Bonds work well for companies that need to raise capital for a longer-term project or need to finance a capital expenditure.
Who issues a loan note?
The issuer of a loan note is responsible for repaying the principal amount of the loan note, as well as the interest payments.
There are a variety of entities that can issue loan notes, including:
Companies: Companies often issue loan notes to raise capital for a variety of purposes, such as expanding their business, investing in new projects, or refinancing debt.
Governments: Governments sometimes issue loan notes to raise capital to finance public projects, such as infrastructure or education.
Financial institutions: Financial institutions, such as banks and credit unions, may issue loan notes to raise capital to lend to businesses and consumers.
Other entities: Other entities, such as non-profit organisations and charities, may also issue loan notes to raise capital for their operations.
The issuer of a loan note is typically required to provide certain information to investors, such as the amount of the loan note, the interest rate, and the maturity date. Investors should carefully review this information before investing in a loan note.
What are the different types of loan notes?
There are a few different types of loan notes, each with its own set of features and benefits.
- Secured loan notes: Secured loan notes are backed by collateral, such as property or equipment. This means that if the issuer of the loan note defaults on their payments, the lender can seize the collateral to recoup their losses.
- Unsecured loan notes: Unsecured loan notes are not backed by collateral. If the issuer of the loan note defaults, the lender has no recourse other than to sue the issuer.
- Convertible loan notes:Convertible loan notes are a type of hybrid security that can be converted into shares of stock at a predetermined price. This gives investors the option to convert their loan notes into equity if they believe the company’s stock price will appreciate in the future.
- Floating-rate loan notes:Floating-rate loan notes have an interest rate that fluctuates based on a benchmark interest rate, such as the LIBOR. This means that the interest rate on the loan note will change over time, but it will never be less than a certain minimum rate.
- Zero-coupon loan notes:Zero-coupon loan notes do not pay interest until maturity. Instead, the investor receives the full principal amount of the loan note at maturity, plus any accrued interest.
The type of loan note that is right for you will depend on your individual investment goals and risk tolerance. If you are looking for a secure investment with a predictable return, then a secured loan note may be a good choice. However, if you’re looking for an investment with the potential for higher returns, then a convertible loan note or floating-rate loan note may be a better option.
It is important to carefully consider the risks and rewards of each type of loan note before investing. You should also do your research to make sure that you understand the terms of the loan note and the creditworthiness of the issuer.
What are the disadvantages of a loan note?
There are some potential disadvantages to be aware of, namely:
- Lack of liquidity:Loan notes can be illiquid, meaning that they may be difficult to sell if you need to cash out before maturity. This is because there is not a large secondary market for loan notes, so there may not be many buyers if you want to sell your loan note.
- Risk of default:The issuer of a loan note could default on their payments, which would mean that you would not receive your full investment back. This is a risk with any type of debt investment, but it is particularly important to consider with loan notes because they are not backed by collateral.
- Low returns:The interest rates on loan notes are typically lower than the interest rates on other types of debt investments, such as bonds. This is because loan notes are considered to be a riskier investment.
- Complexity:Loan notes can be complex financial instruments, and it is important to understand the terms of the loan note before you invest. This includes the interest rate, maturity date, and any other fees or charges that may be associated with the loan note.
Loan Notes in a Business Sale
As mentioned, we see loan notes used in corporate transactions regularly. Consideration Loan Notes or Vendor Loan Notes, as they are sometimes known, are created where there is an element of the overall purchase price (or consideration) being paid at some later date.
Vendor loan notes are typically issued by the buyer of company shares to the seller (or sellers) of those shares as consideration for the share sale. The loan notes represent the element of the purchase price to be paid for the shares that the seller has agreed to defer.
Sellers who receive consideration loan notes may avoid crystallising a taxable gain and “roll it over” into the loan notes. Whether such deferral is advantageous may depend on the vendors’ entitlement to claim entrepreneurs’ relief.
If you’d like to chat through loan notes, need to issue loan notes or are a noteholder in a transaction, get in touch.
