Question

How do you think companies decide which type of private debt they will use? Do they have a choice? Do managers consider what is being offered by financial institutions? Conversely, what do financial institutions look for in firms? What considerations are taken into account by both sides? What kinds of negotiations do you think are involved?

Answer 1

Companies decide to choose private debt by keeping in mind following factors-

1. Interest rate and fee structures- Since, debt taken from bank needs to be paid, company analyses interest rate and applicable fee of banks. Finding favorable, company raises debt.

2. Considering terms of repayment- It is important thing as to whether private debt is of long term or short term. Accordingly, collateral are exchanged or secured borrowings are made between parties.

Furthermore, managers assesses interest rate structure, cost of raising finance in meeting, then arrives at final decision to avail finance or not.

Considerations of financial institutions while they lend to company-

1. Repayment capacity- It is first and foremost important as banks do not want to lose money, they lend to company. Scrutiny is done by them such as net worth of company, value of collateral offered, assets and liabilities so as to assess repayment capacity of enterprise.

2. Need for capital- Banks also evaluates as to for which purpose, money raised will be used, By extracting legitimate reasons, financial institution lends money else reject application.

Thus, by keeping in mind above points, both parties assess each other character and financial condition. Hence, sanction of private debt is made by negotiating certain conditions of debt as company and financial institution as they deemed to be considered.