The cost of borrowing /interest rates is influenced by many parameters such as the amount of loan, Purpose of loan, duration, past business performance of the borrower, borrower’s leadership profile & ethical landscape at Borrower’s end, past loan out-standings and repayment track record, future cash flow/profit projections of the borrower, type of collaterals offered, market situations, credit rating & so on.
5W2H Approach
The 5W2H approach is a problem-solving and decision-making framework that originated in Japan. It is a simple but effective tool that can be used to identify and address the root causes of problems and develop and implement solutions.
You can listen to my YT video on this article as per the link below.
This approach has been utilized in this article, where the 5W2H has been used for developing negotiation strategies for long term borrowings.
Why -1Questions
Q1 Why is long-term borrowing required?
What -10 Questions
Q2 What are the types of debts or long-term borrowing opportunities available?
Q3 What all can be covenants the lender may demand from the borrower?
Q4 What are cost elements in addition to interest costs?
Q5 What kind of collateral lenders can demand to secure the loan?
Q6 What factors can influence interest rates?
Q7 What debt-reduction strategies should the borrower evolve?
Q8 What are the types of risks & risk mitigation strategies?
Q9 What are the statutory issues to comply with?
Q10 What can be the ethical issues in Loan transactions?
Q11 What documents should be kept ready for submission along with loan applications
Who 4 Questions
Q12 Who are the potential sources for long-term funding?
Q13 Who Should Participate in Loan Negotiations?
Q14 Who should sign the loan agreement
Q15- Who are the reputed credit appraisal agencies and their ranking system?
When 1 Question
Q16 When to get loan disbursal and installments of inflows?
Where 1 Question
Q17 Where should be the place of legal jurisdiction?
How 1Question
Q18 How to negotiate effectively?
How much 2Questions
Q19 How much Loan amount should be borrowed?
Q20 How much should be the tenure of borrowing?
To negotiate effectively, some of the essential questions have been identified above (from the borrower’s perspective), and the borrower can add a few more based on the industry applicable and the amount of loan needed.
The negotiating team must equip itself better with possible answers to these key questions before getting into negotiation meetings.
In this article, an attempt has been made to find answers to these questions to serve as valuable information to the borrower.
The questions can be in any order, and each of 5W and 2H can be repeated to dive deep into the subject of long-term borrowing.
For more details,readers can buy my book from Amazon, as per the underlined links given below.
Q1 Why is borrowing required?
Long-term borrowings may be necessary to meet the below type of funds requirements of the organization.
· Financing specific projects
· Expanding operations and Capital expenditure requirements
· Supporting ongoing operations
· Optimizing Debt-Equity ratio
· Meeting part of working capital requirements
· Any combination of the above /any other reasons
·
Q2 What are the types of debts or long-term borrowing opportunities available?
Borrowers have few potential options to evaluate the type of debt funding based on the cost-benefit analysis to be done.
· i)Term loans
· ii)Bonds
· iii)Debentures: Corporate bonds to be issued.
i)Term loan sources
From banks /FI or other parties- FI/Banks offer loans to businesses for capital expenditure and expansion
Loans & advances from related parties-includes loans received from:
Directors or vital managerial persons (KMP),
a firm in which a director or KMP is a director,
or holding or subsidiary, associate company, and so on.
Other lenders: loans and advances -Includes loans from other business entities other than those listed above.
Overseas lending sources: many sources should be included in this article.
ii)Bonds
Bonds are debt securities issued by companies, and the borrower receives cash from the investor who buys such bonds, and the borrower agrees to pay back the borrowed money with interest.
Companies can borrow significant money by issuing bonds in the capital markets.
Bond markets provide companies with access to large amounts of capital, so bonds represent a common, cost-effective source of long-term debt financing.
Bonds are debt securities companies issue to investors and loans secured by assets.
Usually, Bonds pay bondholders a fixed interest rate, also known as the coupon rate. It is also referred to as a fixed-income security.
ii a) Bond options
A list of 8 (eight) types of bonds available in the Indian market is below.
Fixed interest
Floating interest
Inflation-linked
Zero coupon
Callable (which the issuer can pay off before the maturity date.)
Puttable
Perpetual
Convertible
ii b) Evaluating Bonds options to issue.
Negotiating team to decide the following :
Type of bond to be issued,
Face value or at discount or premium -options
Interest rate, frequency, duration, and maturity amount -options
Contents of Bonds issuance prospectus
Determining Bond issuance route
Bonds can be purchased by the investors through markets as under.
Primary market: When the buyer issues bonds for 1st time
·Generally, the bond's entire face amount (principal) is repaid at maturity, and interest payments are paid usually semi-annually or annually.
Companies wishing to raise funds in the bond market typically work with an underwriter (e.g., Goldman Sachs) to set the bond issue terms.
The underwriter sells individual bonds (usually in pre-determined denominations) from this general bond issue to its retail clients, corporations, and professional portfolio managers, and it receives a fee for underwriting the bond issue.
Secondary market: Through exchanges where the bonds are listed and traded
·Bonds are commonly traded through authorized brokers in the bond market.
Once issued, the secondary market bonds can be traded between investors, just like stocks.
Bond market prices fluctuate daily even though the company's obligation to pay principal and interest remains fixed throughout the bond's life.
Bonds can be of the following types.
Redeemable or callable, which the issuer can pay off before the maturity date.
·Non-callable bonds, where bonds cannot be redeemed early by the issuer except with payment of a penalty.
Depending on market conditions, bonds can be issued at face value, a discount, or a premium.
iii)Debentures
Debentures are instruments issued by the borrower that carry the Principal amount and rate of interest payable to the debenture holder at fixed rates, usually yearly or half-yearly.
Debentures are issued under the common seal of the company.
The debenture holder is the creditor of the company and not the owner.
Maturity period: Debentures have a predetermined maturity period, usually medium to long-term, at the end of which the issuer repays the principal amount to the debenture holders.
Priority claim: In the worst case of company liquidation, debenture holders have the right to first claim the company’s assets over equity and preference shareholders.
There are various ways to borrow money against debentures.
Borrower may directly sell debentures to the potential investor
Some debentures can also be traded on stock exchanges so investors can purchase them from the secondary market.
· Debentures are influenced by various factors, as listed below.
·Security
Tenure
Convertible
·Coupon rate
Registration with issuer
Based on the above, the borrowing company issuing Debentures can decide.
1. The type of debenture to be issued.
Secured or unsecured
Redeemable or non-redeemable
Convertible or non-convertible
Specific interest or issue at a discount
Registration requirements
2. The principal amount per debenture instrument and the total amount
3. Rate of interest
4. The debenture issuance route- Direct or through the stock exchange
5. Registration of debenture if applicable
6. Type of charge in case of secured
Bond vs Debenture
Unlike bonds, debentures are unsecured debt instruments not backed by collateral.
The tenure of debentures is usually short-term compared to bonds.
Usually, Private and small companies issue debentures, whereas large corporations, Financial institutions, and Government bodies issue Bonds.
Debentures offer higher interest rates than bonds.
Q3 What all can be covenants the lender may demand from the borrower?
Covenants are the conditions the lender demands and can be any of the following types. The negotiating team must know the consequences of each and negotiate aggressively to protect the interest.
1. Financial :
· Debt-equity ratio,
· Interest coverage,
· Debt service etc
· and so on
2. Operational Restrictions:
· Limits on expenditure on Capex
· M&A
· Dividends pay-outs
· Changes in ownership and control of business operations.
3. Negative:
· Assets sale
· Changes in business operations
· Debt equity changes
4. Financial reporting:
· Profit & Loss
· Balance-sheet
· Cash flow
· Minimum net worth requirements
· Leverage ratios
5. Default covenant:
· Events to be considered as default(eg non -payment of EMI,Finacial covenant, insolvency etc)
· Grace period
· Notice requirement
· Remedies available
· Materiality
6. Compulsory Management Discussions & Analysis:
· Sales & market share
· Profit performance
· Prospects of business performance
Q4 What are cost elements in addition to interest costs?
These are identified below(whether payable to the lender or any other service provider) and the negotiating team must negotiate these aggressively
· Loan processing fees or administration charges
· Credit assessment charges
· Prepayment penalties
· Late payment charges
· ECS /electronic clearance charges for payment
· Default interest rates
· Legal documentation fee (stamp duty & other charges)
· Collateral valuation fee
· Premature closure charges
· Interest rate change charges
· Loan rescheduling charges
· Security creation & registration charges
· Insurance premium costs
· Guarantee charges
· Consultant fee
· Interest swap costs fixed interest rates to variable or vice versa (if applicable)
· Hedging-related costs in case of foreign currency- ECB/Overseas loans
· any other
Q5 What kind of collateral lenders can demand to secure the loan?
These can be the following types: The negotiating team must understand the valuation of these and negotiate which ones can be offered as collaterals considering variability in future and monitoring needed.
Real estate assets: Mortgaging of land, building residential or commercial
Plant & machinery: For manufacturing, assembly, testing, utilities, infrastructure, etc and other tangible assets
Intangible assets: Patents, trademarks, copyrights
Financial Instruments: Hypothecation of Stocks, bonds & other securities
Inventory: Raw materials, WIP, Finished goods.
Cash and cash equivalent: Deposits-fixed, recurring, term deposits, saving banks. Certificate of deposits, Bank accounts and receivables
Guarantees: Personal, Corporate
Q6 What factors influence interest rates?
RBI-related Repo rates: Understanding the concept of the repo rate of RBI, monetary policy
Past interest rate trends Historical trends in interest rates
Inflation: Track of inflation rates
Market forces: The demand and supply in the financial market
Q7 What debt-reduction strategies should the borrower evolve?
· Debt structure optimization (Higher interest rates & lower interest rates)
· Higher revenue (through new products, new markets, pricing, and sales promotion schemes)
· Debt refinancing options
· Better cash flow management vis-a-vis
i)Operational: Inflows: Customers, interest received, dividends.
: Outflow: vendors, employees, taxes
ii)Investing activities:
· Inflow from sales of =Assets, intangibles, securities, & divestitures, loans repayment by borrowers, etc
· Outflows for purchase of =Assets, securities of other cos, acquisitions, investments made, etc
III)Financial activities:
· Inflow from sale of =Equities/stocks, preferred shares, bonds,
· Outflows for =Dividends, buy of treasury stocks, bonds, short-term debt payments, et
· Cost reduction
· Obsolete inventory/obsolete assets sale
Q8 What are the types of risks and risk mitigation strategies?
These have been categorized from the borrower’s and lender's perspectives as below.
1a Risks from the Borrower Perspectives
RBI repo rate is going up, and hence, interest rate increases, mainly if borrowing is against variable interest rates.
Financial stability of lender and non-timely funds disbursal by lender
Market/sales downturn with inadequate sales revenue, profits, and cash inflows
· Intense competition, industry trends, and dropping market share /sales
· Debt-paying capacity going down
· Covenants unfavorable (Financial, operational, default, negative, etc)
· Unethical practices for loan sanction/disbursal
· Market liquidity
1b Risk Mitigation Strategies by Borrower
·Obtaining a guarantee from the lender covering the following.
Loan commitment letter
Non-revocation clause
Default term
Legal recourse available to the borrower
Documentation requirement
·Obtaining an appropriate insurance policy for protecting the interests of borrower vis a vis
Default coverage
Coverage amount
Premium cost
Policy duration
Insurance triggers
claim procedures and timelines.
Meticulous and aggressive review of each covenant, seeking expert legal and financial advise
cautious evaluation of Lender’s credentials, financial stability, reputation
·Debt-restricting strategies in place in case of any eventuality
·Aggressive review and fine-tuning of periodic disbursals
2a Risks from the lender’s perspectives
· Default of EMI by borrower
· Manipulated credit rating of borrower
· Misrepresentation of financial statements or non-transparency of past performance, such as liabilities, P&L, and balance sheet
· Ambitious future growth projections
· Inadequate business growth vis-a-vis projections
· Unfavorable market conditions, regulatory environments
· Quality of collaterals and over-valuation or depletion over time
· Utilization of the funds for the purpose for which these were obtained
2b Risk Mitigation Strategies by Lender
· Robust due diligence and engaging financial/ market experts for evaluation
· Active monitoring of borrower performance in terms of repayments and business performance
· Careful drafting of delayed or default in EMI payments clause in the agreement and legal recourse available to the lender
· Thorough vetting of Guarantees to be obtained from the borrower
· Cautious evaluation of Borrower’s credentials, past track of loan repayment, market standing, management reputation
· Careful drafting of covenants while ensuring win-win
· Aggressive mechanism to monitor timely receipts of EMI from the borrower
· Cautious examination of compliance with documentation requirements
· Proper monitoring of funds utilization through monitoring/physical visits to the premises of the borrower
Q9 What are the statutory issues to comply with?
Fifteen requirements are compiled below.
Co’s Act 2013 related
· Proper books of accounts
· Conducting annual audits
· Filing annual returns with the Registrar of Companies
· Conforming to Corporate Governance
Security creation & registration
· Registration of mortgage, charge or hypothecation over the assets with Registrar of Companies or
· Central registry of securitization and asset reconstruction and security interest
Regulatory approvals
· SEBI or RBI or sector- specific bodies
Tax compliances e.g. GST,
· Income tax (withholding tax on interest payments)
· Timely filing of tax returns
Anti -Money laundering Reporting suspicious transactions
Credit ratings
· For debt securities or demanded by Institutional lenders
· Reputed agencies to be used like:
Crisil-credit rating information services of India
ICRA -investment information and credit rating agency of India
CARE -Credit Analysis and Research Ltd.
Moody’s
Standard and poor’s
Fitch and so on
Other regulatory approvals
· Compliance as required by Lenders such as environmental clearances, Labor laws, health and safety, insurance etc.
· Sector -specific requirements
Q10 What can be the ethical issues in loan transactions?
· Borrowing company engaging in unethical practices such as below
Influencing third parties such as merchant bankers, appraisers, or advocates and using unfair means to get a favorable report about the company’s health.
Providing false or misleading representation of its financial health, assets, liabilities, profitability, cash flow projections, etc.
Concealing existing debts intentionally.
Sharing confidential information of offers of other participating lenders with some lenders to gain an unfair advantage or in return for undue personal favours.
Offering Assets as collaterals that are either non-existent or overvalued
Offering bribes to lending bank officials to get a favourable report for loan sanction with better terms.
Negotiating interest rates, terms, and conditions without the free consent of the company’s approving officials
Getting into an agreement under coercion or undue influence of borrowing company‘s official who is in a position to dominate the will of others and using that position to obtain an unfair advantage over the other
Lending FI/Bank engaging in unethical practices such as below
Providing misleading information about hidden costs, terms, and covenants.
Offering loans at exorbitant rates or unfair terms considering the status of the borrowing company.
Negotiating rates/terms through unfair means under the influence of lending company officials.
Offering bribes to borrowing companies.
Sharing confidential information with malicious intent in return for personal gain.
Negotiations are done by persons neither competent nor authorized to negotiate or get into a contract.
Both borrowing & lending companies collude to negotiate :
Deals with kickbacks.
Unlawful terms.
Q11 What documents should be kept ready for submission along with loan applications? (for the period asked by Lender -past and projections)
Past period /existing as asked by lenders.
· Purpose of borrowing
· Plants, Products & services, capacities, manpower, key vendors & business associates
· Sales (domestic and export) Product range, Market analysis, market share, Distribution channels, competition analysis,
· Capital expenditure.
· Top Management profile
· Financial statements-income, balance sheet & profitability projections
· Available cash and Cash flow
· Collateral availability & values
· Credit score ratings
· Retained earnings.
· Existing debt obligations, Debt service coverage ratios, and leverage ratios
· Taxes paid.
· Statutory compliances overview
Future Projections as asked by lenders.
· Business plans w. r. t.
Plants, Products & services, capacities, key vendors & business associates
Sales (domestic and export), Product range, Market analysis, market share, Distribution channels, competition analysis,
Capital expenditure.
· Cash and Cash flow projections
· Potential contingencies
· Liquidity projections
· Tax estimations
· Statutory requirements
· Risk assessment (market condition, competition, regulations)
· Covenants
Q12 Who are the potential sources for long-term funding?
1)FI/NBFC: A few examples of FI are as below:
· Financial institutions (for infrastructural projects and industrial development)
· NBFC: For project finance, infrastructure finance, equipment leasing, etc
· Infrastructure finance companies: for infrastructure projects like Airports, seaports, Highways
They offer loan products like commercial term loans, project finance, and syndicated loans and provide funds against bonds and asset-backed securities.
Rates and terms
They may offer competitive rates for specific sectors and are likely more flexible in negotiations than Banks. FI may offer longer tenure funds for infrastructure/long projects but with complex Covenants. Due to rates/flexibility reasons, they may demand stringent Collaterals.
2)Banks: They may be public-sector or private banks. They offer Commercial term loans, project finance, syndicated loans, equipment financing, structured finance, etc. However, interest rates may be higher than FI due to regulatory requirements, particularly with Public sector banks.
Rates and terms
Rates could be lower with existing customers. Collateral requirements may vary based on the loan amount, duration, and risk assessments.
3)Private placement
It involves raising capital by issuing securities directly to institutional investors. These are typically used for companies looking to expand or restructure financial debts. The borrowing company retains control as there is no transfer of ownership. Investors hold security until maturity, are not involved in day-to-day operations, and lend to established companies and thus have low-risk perceptions. There is precisely no exit strategy.
Notes:
i)Borrowing through FDI is not included in this article, though it is relevant when foreign currency requirements are envisaged.
ii)Raising money through Equity/IPO, Venture capital, and Private Equity are not considered part of Debt and hence not covered.
Venture capital
Here, venture capitalists fund borrowers who are usually early start-ups (usually high growth potential and early stage, in exchange for ownership. They provide mentorship, may join the board, and actively participate in company affairs.
The exit strategy is usually acquisition by a larger company or through an IPO. Risks perceived by venture capitalists are higher as start-ups may fail.
Private Equity
This refers to investments made by private equity firms to well-established mature businesses with revenue -generation. It involves significant ownership and, hence, higher stakes in the management and strategic matters of the borrowing company. The exit strategy can be like selling the company or going public. Risks in such borrowing are moderate to high.
Q13 Who Should Participate in Loan Negotiations?
The suggested team should comprise of:
· CFO+ Legal head+
· Independent Financial Advisor /firm
· Loan negotiation experts
Approval from the board sub-committee must be taken before signing the loan agreement,
Q14 Who should sign the loan agreement?
Preferably by CFO+ Legal head after principal approval of the loan by the board sub-committee
Q15 Who are the reputed credit appraisal agencies, and their ranking system?
Indian
· CRISIL (Credit Rating Information Services of India Limited)
· ICRA (formerly Investment Information and Credit Rating Agency) Limited.
· CARE (Credit Analysis and Research Limited)
International
· Standard & Poor's,
· Moody's Investors
· Fitch
The details of rating systems are given in my book
Q16 When to get loan disbursal and installments of inflows?
Initial Loan disbursal should be scheduled by the Borrower just in time for the fund's requirements based on the Capital expenditure plan/expansion plan after factoring in the following:
· Advance requirements of the vendors /service providers/consultants ( at the design stage & negotiation stage) of the expansion project /new capex requirements after fine-turning in consolidated amounts
·At the time of shipping of significant equipment by the vendors
·At the time of installation, testing, and commissioning of such equipment
·At the time of prototyping, production, and sale launch of the products/services by the borrower
Q17 Where should be the place of legal jurisdiction, and which laws be applicable?
· The place of jurisdiction should be preferably the city /state of the registered office of the borrower.
· Alternatively, it could be where business operations are performed, i.e., where the equipment/facilities procured out of borrowed funds are utilized.
· For any deviation, the legal team should be consulted.
· In any case, the laws of India must be applicable.
· Negotiations can be held anywhere mutually convenient ·
Q18 How do we negotiate effectively?
Once the management has decided to raise money through a term loan (vis a vis Bonds or debentures), the negotiating team must do the following.
1)Shortlisting Term loan sources based on at least the below considerations.
· The lender’s financial standing
· Experience in taking the loan.
· Reputation
· Track record
· Customer (Borrower’s) feedback
· Industry/market familiarity
2)Competitive bidding
The negotiation team must prepare a Request for a quote from shortlisted FI/Banks and arrange competitive bids.
3)Comparison chart
The negotiating team will make a comparison chart of rates, terms, and covenants before initiating negotiations as per the template below.
4) The negotiating team must be fully equipped with all essential negotiation aspects, such as below, and compiled in templates 1 & 2 and initiate dialogue with each shortlisted lender (Templates are enclosed at the end of the article)
5) Borrower should review and evaluate willingness to offer collaterals based on the company’s ability, risk appetite,
6) The strategy should be to create a win-win during negotiations such that
· Borrowing costs are optimized.
· Signing agreements with terms, conditions, and covenants with the understanding of mutual requirements
· Timely disbursal of loans and funds availability with borrower
· Maintaining excellent relationships among lender and borrower teams but at arm’s length
· Carry out negotiations such that regulatory requirements are not compromised
· Negotiating with a 100% ethical frame of mind.
· The comparatives must be accurate and approved to be signed by the CFO and legal head.
Q19 How much loan to borrow
Factors influencing are.
· Business plans –Sales, Products, Market-local and export, Market share
· Purpose
· Capital expenditure plan.
· Potential contingencies
· Projection of -Income, balance sheet & profitability
· Available cash and Cash flow projections
· Retained earnings and equity enhancement plans.
· Existing debt obligations, liquidity projections, Debt service coverage ratios, and leverage ratios
· Cost of Debt
· Statutory and Tax regulations
· Risk assessment (market condition, competition, regulations)
Q20 How much should be the tenure of borrowing?
Tenure can be broadly classified as below:
Short- term =1-3 years, Medium -term=3-7 years , Long -term > 7 years
Borrowers need to determine the amount of borrowing required and the number of installments based on the estimated /projected cash flow and formulate a strategy to negotiate this with the lender.
Usually, the longer the tenure, the higher the interest rates, but it offers the lowest monthly EMI.
Medium-term loans offer a balance between lower interest rates and manageable monthly payments.
Way forward
·Long-term borrowing sources in India offer many opportunities, each with cost perspectives, statutory considerations, and ethical issues.
·Choosing the right source depends on the borrower’s financial needs, risk appetite, market conditions, benchmark interest rates, and ethical and statutory compliance commitment.
·There has to be absolute fairness in terms of financial reporting, fairness of collateral valuation, and wordings of Covenants that inspire confidence.
By carefully weighing these factors, borrowers can secure long-term financing that aligns with the goals of the borrowing company while upholding legal and ethical standards.
Template 1- Costs related Comparatives -in Unit of measurement-….(more lenders can be added)
Evaluation parameters | Lender 1 | Lender 2 | Lender 3 |
Loan amount | | | |
Interest rates | | | |
Interest -Fixed or variable | | | |
EMI Amount | | | |
EMI start date | | | |
EMI end date. | | | |
EMI number of instalments | | | |
Total cost of borrowing | | | |
Total repayment amount | | | |
Advance EMI amount | | | |
loan processing fee or administration charges | | | |
Credit assessment charges | | | |
prepayment penalties | | | |
Late payment charges | | | |
ECS /electronic clearance charges for payment | | | |
Default interest rates | | | |
Legal documentation fee (stamp duty & other charges) | | | |
Collateral valuation fee | | | |
Premature closure charges | | | |
Interest rate changecharges | | | |
Loan rescheduling charges | | | |
Security creation & registration charges | | | |
insurance premium costs | | | |
Consultant fee | | | |
Template 2 -Comparison of Collaterals, Covenants, and other aspects
(Specific Details are to be captured against each lender, and more lenders can be added)
Evaluation parameters | Lender 1 | Lender 2 | Lender 3 |
Collateral-Real estate assets | | | |
Collateral-Plant & machinery | | | |
Collateral-Intangible asset | | | |
Collateral- Financial Instruments | | | |
Collateral- Inventory: | | | |
Collateral- Cash and cashequivalent | | | |
Collateral- Guarantees | | | |
Covenant- Financial | | | |
Covenant- Operational Restrictions | | | |
Covenant- Negative | | | |
Covenant- Financial reporting | | | |
Covenant- Default covenant | | | |
Covenant- Compulsory Management Discussions & Analysis: | | | |
Security documentation/ Charge creation | | | |
Reputation & dependability | | | |
Top Management profile | | | |
Past loan experience | | | |
Financial health, stability | | | |
value-added services offered such as advisory, industry expertise | | | |
Potential synergies offered | | | |
Risk assessment w.r.t lender | | | |
Specific terms | | | |
Assessment of financial expert/legal advisor | | | |
Notes for template 1&2 :
More columns /rows can be added to include additional lenders /evaluation parameters
Separate sheets may be required for each lender for clarity