While many of us have taken out loans before or at the very least know how a loan works, the legal side of loans is an area majority of people are unaware of, despite them playing such a crucial part in the borrowing of money from a bank.
While many of us have taken out loans before or at the very least know how a loan works, the legal side of loans is an area majority of people are unaware of, despite them playing such a crucial part in the borrowing of money from a bank.
This includes loan notes, an essential factor when it comes to loans and debts that is always worth learning about, especially since they actually come with a few benefits that can make them more ideal to use than standard loan agreements.
Here is all you need to know about loan notes, including what they are, how they affect the loaning process, and the reason why you should consider using one the next time you decide to take out a loan.
How Does A Loan Note Work?
While there are many legal and financial factors that make up a loan note, in the simplest terms, it is a financial instrument which is used as evidence of a debt between the borrower and the lender.
The loan note guarantees that the person borrowing the money will repay the amount to the lender at a future date that has been mutually agreed upon.
This loan note will therefore set out the terms and conditions that are related to the debt, including when the debt is to be repaid, conversion requirements, and provisions on any interest that is added on.
An important detail included in the loan note is information on the security the borrower will provide to secure the loan if they are unable to pay the interest or the capital back at the end of the agreed term.
In this sense, loan notes are much the same as an IOU or bill of exchange between two parties, however unlike an IOU, a loan note also works as a legal contract with more specifications on the agreement, such as the duration of the loan.
Who Uses Loan Notes?
A loan note can be used by anyone, whether it be an individual, company, organisation or a partnership, however it is most commonly used between a consumer or investor and a business or company.
There is therefore no limit to who can issue a loan note, however certain types of loan notes will be more suitable to individuals than others since they can be more tailored towards different parties and organisations.
What Are Convertible Loan Notes?
Convertible loan notes are most often used between companies and an investor and are essentially loan notes which can be converted into equity which are often used when a company is in urgent demand for money.
In this sense, it still works as a financial instrument to guarantee the agreement between the two parties and still details the agreements made between both parties, including how much is being borrowed and how it must be paid back.
Additionally, convertible loan notes will also need to set out the conversion event, which essentially means when the loan note will actually convert into equity and if there is expected to be a longstop date on the conversion.
It should also lay out the conversion discount, which usually takes the form of a formula for the calculation to convert the debt into shares. These shares are most often converted at a discount, and depending on the generosity of this discount, it can make other terms in the loan note seem more favourable.
Can A Loan Note Be Transferred?
This all depends on the terms and conditions of the loan note itself. If the terms allow for a transfer, then it can be done, however, the loan note holder will need to relinquish the certificate and all included rights to the new holder in order for the transfer to take effect.
Additionally, in order to protect the interest of both parties involved, these terms would need to be agreed upon well in advance so that no transferring takes place without a party’s permission.
It should also be noted that many private equity transactions that are involved in stocks are a lot more difficult to transfer and will often come with restrictions on how you can transfer and with how much.
Can Loan Notes Be Secured?
If any assets are to be secured, the loan note will usually contain a statement making this clear. The obligations under a loan note can be secured, however this is not a requirement and is entirely up to the parties.
The terms within the note are often contained in a security trust deed. The security trustee then has the duty of enforcing the security in accordance with the requirements that are stated within the loan note. A security trustee is most often appointed when a loan is secured with multiple noteholders.
Reasons To Use A Loan Note Over A Loan Agreement
While loan agreements in their simplest form are quite easy to create, loan notes on the other hand are much more complex to actually implement, however, there are a few scenarios when somebody would consider using them instead.
If a person is looking to raise money from the public, loan notes work better because, unlike loan agreements, you can publicly list them. With that being said, it should be kept in mind that private companies are not allowed to offer any securities to the wider public.
Loan notes can also be more optimal for investors, usually used in a private equity transaction by smaller companies who will issue loan notes to private equity investors who will then provide the majority of their investment.
If there are also no obligations for the lender other than to advance the initial money, a loan note holder will not need to sign anything, making the loan note far simpler to implement than a loan agreement, especially if there are multiple noteholders.
Summary
Loan notes are incredibly important financial instruments when it comes to loaning a person or company a certain amount of money, and they actually come with several benefits over standard loan agreements.