Issuing Debt Securities Privately

  • Debt financing can be raised by companies through private placement offerings in amounts ranging from less than $100,000 to well over $1,000,000,000.  

 

  • Maturities (i.e. when the principal is due to be repaid) can be short-term (say 90 days) to over 10 years.  In many cases, “amortizing” structures involving the scheduled, partial return of principal over the life of the debt security are incorporated into the issuance terms.  In all cases the repayment cycle of a debt security’s principal should match the projected profitability of the securities issuer, so the company can comfortably repay the borrowed capital when it is due.

 

  • Debt securities are also referred to as “fixed income” securities because they provide investors with a specified, “fixed” rate of return through an annual interest rate that the issuer is obliged to pay, typically monthly or quarterly.  Equity securities, on the other hand, provide investors with a share of the issuer’s profits, which will vary over time, but would be expected to provide investors with a much greater overall return than a debt security of the same issuer.  Hence, from the issuer’s perspective, debt is a less expensive form of financing than equity issuance.

 

  • The level of the interest rate required to obtain sufficient investor demand will reflect the credit quality of the issuer and also the maturity of the security offered.  Longer maturity securities typically require a higher interest rate than shorter term securities.  Interest rates may be fixed for the life of the security or they may float over time in relation to a recognized index, such as the US bank Prime Rate or LIBOR.

 

  • The credit strength of a debt security and the related investor demand can be enhanced by “collateralizing” the security with assets of the issuer having recognized value and which can be unilaterally sold by the investor to achieve a return of their investment, in the event that the issuer cannot meet its redemption obligations.

 

  • Debt securities may also incorporate warrants, a form of purchase option, for equity securities of the issuer as a means to offer a greater potential return to the investor.  Offering warrants with a debt offering may be necessary to generate investor demand given the risk profile of the debt being offered.

 

  • Debt generally offers the issuer much less flexibility than equity in terms of future financial obligationsto investors.   Not paying the principal or interest when due on a debt security would result in a “default” event and trigger events that would restrict the issuer’s operations until the default is “remedied” or potentially force the issuer’s bankruptcy and liquidation.  Therefore, debt should only be offered by companies having a base of operation that generates sufficient cash flow to meet the principal and interest payments specified by the security offered.

 

  • Debt securities can be structured for continual issuance in “tranches” when there is an ongoing need for debt financing by an issuer, but not all of the capital is required a particular point in time.

 

  • Credit ratings on a specific private debt security, which can be assigned from third parties such as a nationally recognized rating service or the NAIC, can significantly increase investor demand while reducing the interest rate required by investors, but these are only available for the securities of larger, well-established companies.

 

  • In general, debt securities issuance should not be conducted by companies with limited operating histories, given the stricter principal and interest payment compliance requirements of debt and the less proven financial performance of a newer company.  Less established companies should raise capital through equity issuance, even though it is a more expensive form of financing.