We’ve introduced bonds as a type of debt instrument and used them to highlight the main characteristics of debt products. Now, you will discover that many other financial products operate on the same principle: offering returns that are not tied to a company’s financial performance, along with a commitment to repay the debt.

1. MARKETABLE DEBT SECURITIES

Bonds, as discussed in the previous chapter, represent a key form of long-term marketable debt. However, companies also have access to other debt instruments for both short-term and long-term financing needs.

For short-term marketable securities, commercial paper is a popular option. These are negotiable debt securities with maturities ranging from one day to one year, though most typically mature within one to three months. Companies can issue commercial paper in different currencies and tap into markets like the European Commercial Paper (ECP) market, based in London, or the regulated French Titres de Créances Négociables (TCN) market. The STEP label, introduced in 2006, has standardized documentation across Europe for short-term paper. Commercial paper allows companies to bypass banks, borrowing directly from investors at competitive rates close to money market levels. While obtaining a credit rating is not compulsory, it’s generally advisable for credibility. Issuers often set up backup credit lines to ensure they can maintain high ratings, especially during periods of market instability, such as after the 2008 Lehman Brothers crisis. This instrument offers flexibility in terms of maturity and rates but is less adaptable in terms of issue amounts.

On the long-term side, bonds continue to dominate, but private placements offer an alternative for companies seeking long-term financing without the need for a public rating. Private placements, typically structured like bonds, are aimed at institutional investors and are common in the US, Germany, Belgium, and France. These instruments offer longer maturities, usually between seven and fifteen years, and are often more flexible in terms of issue size. While private placements come with strict covenants, they provide an appealing solution for companies looking to diversify their funding sources, particularly as traditional bank loans have become more restricted due to tighter banking regulations. This growing shift towards non-bank financing solutions, often referred to as shadow banking, highlights the increasing role of private placements in corporate financing.

2. BANK DEBT PRODUCTS

Banks offer a variety of credit products tailored to meet the specific needs of their clients, which differ from traditional market financing options. Business loans, which are not tied to specific assets, are one such product and are typically based on interest rates and the overall risk profile of the company. These loans can be negotiated either with a single bank, known as a bilateral loan, or with multiple banks when larger sums are involved, resulting in a club deal or syndicated loan. Business loans often serve as a backup mechanism for companies to cover cash payments, and banks usually compete by offering the lowest interest rate. While these loans don’t come with ancillary services, their terms are determined based on market rates, maturity schedules, and the company’s credit risk. Banks lend based on the borrower’s financial health, and companies with strong capital structures can usually secure financing, provided they adhere to certain financial conditions.

Types of business loans

Businesses have access to several loan types, each suited to different financing needs:

• Overdrafts: These help companies manage temporary cash shortages, though they come with high costs and, for smaller enterprises, are often backed by collateral.
• Commercial loans: Popular for short-term needs, these loans are easy to set up and are based on the bank’s refinancing rate, with an added margin depending on the borrower’s creditworthiness.
• Revolving credit facilities (RCFs): These are flexible credit lines that a company can draw on when needed, paying only a commitment fee on undrawn amounts.
• Term loans: Typically used for specific investments, term loans are less flexible than RCFs, often allowing early repayment but prohibiting re-borrowing of repaid amounts.
• Bridge loans: Designed to quickly finance investments, these loans cover short-term needs and are repaid once long-term financing is secured. They are expensive due to the high risk they pose to the lender.
• Syndicated loans: Used for large sums, often exceeding €50 million, these loans are arranged by a lead bank that shares the loan with other banks. Fees are distributed based on each bank’s participation in the deal.

Features of loan documentation
Loan documentation outlines the essential terms and conditions of the agreement. Key elements typically include:

• Loan amount, maturity, and the purpose of the loan.
• Disbursement terms, specifying how the funds will be made available (as a single payment or on request).
• Interest rate structure (fixed or floating), payment schedules, and any fees involved.
• Repayment terms, including early repayment options.
• Guarantees or pledges, if required.
• Covenants, which are conditions attached to the loan, such as:
  o Positive covenants: Requiring the borrower to meet certain financial ratios or structures.
  o Negative covenants: Limiting actions like new loans, asset pledging, or dividend payouts.
  o Pari passu clauses: Ensuring the lender gains from any additional guarantees provided to future creditors.
  o Cross-default clauses: Triggering immediate loan repayment if the borrower defaults on another loan.

Additionally, some agreements may include Material Adverse Change (MAC) clauses, allowing the lender to cancel the loan if the company’s financial situation deteriorates significantly. In Europe, loan documentation for syndicated loans is often standardized, thanks to efforts by the Loan Market Association (LMA). The loan market fluctuates in line with economic conditions—tightening during financial crises and offering more favorable terms in periods of high liquidity. Since 2010, the market has stabilized, providing companies with improved access to credit.

3. FINANCING LINKED TO AN ASSET

Discounting

Discounting is a financial technique that helps firms manage short-term cash flow gaps between invoicing and collection, specifically backed by trade receivables. In a discounting arrangement, a company provides a commercial bill of exchange to a bank in exchange for an advance, less interest and fees. The bank assumes ownership of the bill and seeks repayment from the company’s customer. If the bill is unpaid at maturity, the company bears the risk (known as discounting with recourse). This method allows companies to leverage their receivables for better financing rates, given that banks often have more insight into the creditworthiness of the company’s customers than the company itself. Discounting, however, does not finance the company directly but focuses on specific receivables. Many banks now offer non-recourse discounting, where the bank assumes the risk if the bill remains unpaid, allowing the company to remove the receivables from its balance sheet and reduce contingent liabilities.

Factoring

Factoring involves a company selling its outstanding trade receivables to a financial institution or factoring company at a discount. In exchange, the company receives immediate payment, minus interest and commissions. Factoring companies specialize in purchasing receivables and often provide additional services such as financing at attractive rates, debt collection, insurance against non-payment, and off-balance-sheet financing. Unlike discounting, factoring typically includes these extra services, enhancing its value for companies. Banks are increasingly offering non-recourse factoring, meaning they assume the risk of unpaid invoices, which helps remove contingent liabilities from the company’s financial statements.

Leases

Leasing is a financial arrangement where a firm (the lessee) pays fixed amounts to use an asset owned by another party (the lessor). The lease payments, which can be monthly or semi-annually, may be tax-deductible depending on the lease’s accounting classification. Leases can be categorized into operating leases, which have a term shorter than the asset’s economic life and allow the asset to revert to the lessor, and financial (or capital) leases, which typically cover the asset’s entire economic life. Operating leases offer flexibility and less risk, while financial leases often lead to asset ownership at a reduced price. From an accounting perspective, finance leases are capitalized, and the lease payments are split into principal and interest, while operating leases are expensed. Firms might choose leasing to avoid the financial burden of purchasing assets outright, manage balance sheet liabilities, or bypass restrictive bond covenants.

Sale and lease back

Sale and leaseback is a transaction where a company sells an asset, such as real estate or equipment, to a leasing company and immediately leases it back. This can help extend the duration of debt or reduce debt costs. In consolidated financial statements, the asset remains on the balance sheet, while the corresponding financing appears as a liability. The operation’s purpose might be to improve cash flow for new investments or restructure the balance sheet. Companies in various industries, including retail and hospitality, use this strategy to free up cash and reduce on-balance-sheet debt, though they need to carefully consider tax implications and accounting impacts.

Export credit

Export credit, or buyer’s credit, finances export contracts by providing funds to the buyer of goods or services. The bank pays the supplier directly, and the borrower repays the bank under specified terms. This type of credit offers benefits like insurance against payment defaults, reduced cash requirements, and no need for foreign exchange hedging. Export credits can also facilitate large projects similar to project financing. They help manage liquidity and financial risk in international transactions, especially when the first payments are made before contract completion.

Securitization

Securitization is a financial process where banks convert loans or receivables into negotiable securities. A bank pools loans with similar risk profiles into a Special Purpose Vehicle (SPV), which issues securities to investors. The SPV uses the proceeds to buy the loans and manage repayments. To enhance security ratings, the SPV might over-collateralize or secure insurance. Securitization allows companies to convert assets into liquid capital and finance them at favorable rates, though the process can be costlier than traditional debt. This technique has faced challenges due to the subprime crisis, but remains viable for high-quality assets and transparent structures.

Project financing

Project financing is used for large-scale projects, such as infrastructure or natural resource extraction, where funds are raised based on the project’s cash flows and assets rather than the borrower’s credit. Initially used in the 1930s for oil prospectors, this financing method relies on detailed project analysis and involves significant risk. Projects are financed through a separate entity, and lenders often require guarantees from the parent company. Risks include cost overruns, delays, and economic or political upheavals. Mitigation strategies involve insurance, performance bonds, and long-term contracts. This type of financing is suited for well-defined projects with stable returns and expertise, and it can involve international and export-facilitating organizations to support financing and risk management.

In conclusion, debt products provide companies with diverse financing options, from short-term commercial paper to long-term bonds and private placements. These tools help businesses manage their funding needs while diversifying away from traditional bank loans. In the next article, we will shift focus to company shares/stocks, which, unlike debt, are tied directly to a company’s financial performance.