The first thing most companies put in front of investors is the coupon. It is also the thing experienced investors look at last.
A high rate tells an investor what they are being promised. It says nothing about whether the promise will be kept. The questions that decide a loan note raise are about the route back to the investor’s capital, and they are remarkably consistent from one investor to the next.
Here are the seven we hear most often, and what a good answer looks like.
1. How exactly does the money come back?
This is the question underneath every other question. An investor wants to see a specific source of cash that will pay the interest and repay the capital on the stated date.
Good answers are concrete: contracted revenue, the sale or refinancing of an identified asset, a planned listing, or a larger funding round that is already in progress. Weak answers rely on general growth. “The business will be much bigger by then” is a hope, not a repayment plan.
2. What is the money for?
Investors like to see capital going into something that produces the cash to repay it. Funding a property that will be sold, stock that will be sold on, or a contract that will be paid is easy to follow. Funding operating losses with debt is much harder to justify, because the capital is consumed rather than converted.
A clear use-of-funds table, tied to the repayment plan, answers this question before it is asked.
3. Is it secured, and against what?
Security gives the investor a claim on specific assets if the company defaults. It is one of the strongest signals in a loan note, but only if it is real.
Investors will ask what the asset is, who valued it and when, whether anyone else already has a charge over it, and how quickly it could be sold. Security over an asset worth less than the debt, or already pledged to a bank, gives far less protection than the word suggests.
4. Where does the note rank?
If the company fails, creditors are paid in order. A note that ranks behind a bank loan or other senior debt is only repaid once those lenders are paid in full.
Investors will want a simple picture of every existing liability and where the new note sits. Hiding or glossing over senior debt is one of the fastest ways to lose an investor’s trust.
5. Who stands behind the company?
Loan notes are often issued by young companies or special purpose vehicles with limited history. Investors therefore look through the company to the people and assets behind it: the directors’ track record, whether a parent company or shareholder gives a guarantee, and whether the founders have their own capital at risk.
A guarantee from a substantial party can transform a note. So can evidence that management has delivered similar projects before.
6. What happens if something goes wrong?
Investors do not expect a plan to go perfectly. They want to know what the document says when it does not.
That means clear events of default, the notice periods, whether interest continues to accrue, whether investors can appoint a trustee or security agent to act for them, and whether the company can extend the term, and on what terms. Notes that allow the company to extend unilaterally, with no extra return, are read as a warning.
7. What will I be told, and when?
Private debt investors are often less informed than shareholders. Good issuers fix that by committing to regular reporting: quarterly updates, annual accounts, and prompt notice of anything that affects repayment.
A reporting commitment in the loan note instrument costs the company little and tells investors a great deal about how it intends to behave.
The coupon comes last
Only once those questions are answered does the rate become meaningful. At that point investors judge it against the risk they have just assessed. A modest rate on a well-secured note with a clear repayment route will often raise faster than a high rate on a note that leaves questions open, because the high rate reads as the company pricing in risk it has not explained.
Preparing before the first meeting
Companies that raise well tend to prepare a short pack that answers all seven questions in writing: the loan note instrument or term sheet, a use-of-funds and repayment schedule, a summary of security and valuations, a list of existing creditors, and brief biographies of the directors. We cover the wider document set in investor-ready documentation.
If you are still deciding whether a loan note is the right instrument at all, start with what a loan note is and how it works, and compare it with a bond in bonds or loan notes: which suits your raise?
Rules on who can be offered loan notes, and how, differ by country. Take legal advice in each jurisdiction where you plan to raise.
Mark Johnson is a Director of BDM Wealth Management, which introduces capital raising opportunities across bonds, loan notes, IPOs and SEIS/EIS. To discuss a raise, get in touch.
BDM Wealth Management is an introduction business and is not regulated. This article is general information, not financial, tax or legal advice, and does not constitute an offer or invitation to invest. Capital is at risk and you may get back less than you invest. Tax treatment depends on individual circumstances and may change. For high-net-worth and sophisticated investors only. Take independent professional advice before making any investment decision.