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Loan notes explained – a guide to loan notes for businesses

Posted by Todd Davison on Dec 16, 2021 9:54:57 AM

Loan notes, promissory notes, bill of exchange; whatever you call them, they’re an integral part of modern business and financial management. 

Many of us have been conditioned to believe that debt is universally a bad thing, which (in business) it often isn’t. 

Loans are a fantastic way for businesses to grow exponentially, making a bunch of money in the process. In fact, there’s very few businesses out there that weren’t started without some form of seed capital.

In this article, we’ll run through the basics of loan notes – what they are, who they’re for and why they’re worthwhile. 

What is a loan note?

A loan note is a legal agreement between a company and a lender (bank or financial institution). The lender agrees to make a loan to the company, and the company agrees to repay the loan (with interest) by a specified date.

This makes a loan note instrument akin to an IOU note, just with legal precedent and consequences should anyone break the agreement. 

Loan notes are often used to finance a business, but can also be used when making significant purchases (such as car finance, mortgages, key assets, et cetera). 

What are the benefits of loan notes?

As the more flexible cousin of the loan agreement, loan notes are fairly quick to create, and offer some legal precedent (and protection) for the lender. Some of the key benefits of loan notes are:

 - Legally actionable – loan notes are the legal alternative to a scrap of paper with ‘IOU’ scrawled on it.

 - Quick & easy – it doesn’t take too long to write up a functional loan note.

 - Reassure lenders – as there’s a guarantee that you’ll pay off any debts before insolvency, investors can rest assured that their finances are safe.

 - Tax advantages – protect individuals from the tax liability associated with a lump-sum payment or cash package

 - Protect your equity – a loan note allows you to get funding without giving away equity.

Many new businesses rely on loan notes to help secure vital funding for their business; they’re an incredibly powerful tool to be used, as long as they’re used carefully!

Are there different types of loan notes?

While there are no distinct ‘types’ of loan notes, there are some key factors that differentiate one from another.

Secured

Any secured loan note is one that’s insured using the borrower’s assets as collateral. This is also known as a personal guarantee

This provides legal assurances to the lender that, in the event of the business going under, their investments are secure.

Traded loan notes

An alternative to using physical assets or liquid funds to secure a loan, some choose to use company stocks as collateral instead.

Should debts not be able to be paid, stocks will be sold to cover the costs.

Unsecured

Unsecured loan notes are significantly rarer than secured, as there’s no personal obligation to repay debts should the company collapse. 

This means that there’s a great deal of trust involved in an unsecured loan, and a significantly higher risk for the investor. 

Convertible loan notes

Used when a business needs rapid access to liquidity, a convertible loan note can be (as the name suggests) converted into equity either after an agreed period, or if a specified event occurs.

In order to ensure a thorough understanding from both parties, the parameters of the loan note need to be clearly outlined at the outset in order for it to be valid.

Can loan notes be transferred?

If the terms and conditions of the loan note allow for transfer, then the answer’s yes. These terms need to be agreed well in advance in order to ensure that both parties’ interests are protected.

In order to be transferred, the loan note holder will need to make sure that the certificate and all rights are relinquished to the new holder.

Worth noting: many private equity transactions (involving stocks) are more difficult to transfer, and as such will often include restrictions on transferability. This will usually manifest as certain aspects of the loan note being transferrable, and others not being so. 

Are loan notes for business use only?

Not necessarily. Loan notes can be used by anyone: individuals, companies, partnerships, organisations – there’s no real limit to who can issue a loan note.

Obviously, certain types of loan notes are less suitable for individual lending (a convertible loan note, for example, as there is no company involved to issue share capital).

How to protect your assets when borrowing money

Most loan notes require a personal guarantee in order to secure the investment. This means that many people put a lot of their own capital on the line when taking out a loan.

Personal guarantees hold the directors/founders personally responsible for repaying any debts, meaning that if company assets cannot cover what’s owed, then you could find yourself personally liable for paying back large amounts of money.

The answer? Personal guarantee insurance.

By insuring some (or all) of your personal guarantee, should the worst happen, and your business becomes insolvent, you’re safe in the knowledge that much, if not all, of your investment is safe.

Personal guarantee insurance with Purbeck

There’s no reason that your personal guarantee should weigh on your conscience. At Purbeck, we understand that signing a personal guarantee can leave you feeling exposed. 

Let us take that stress away. Our insurance policies cover up to 80% of the value of your personal guarantee, allowing you to focus on growing your business rather than worrying about any associated personal risks.

Get in touch with our team of specialists today to find out more about our offering. 

Topics: #pgi, #personalguarantee, #personalguaranteeinsurance

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