How to choose the appropriate Debt Instrument?

Hi guys,

I know it could sound like a dumb question... but don't get me worng here.
How does someone "choose"/select the appropriate debt instrument to finance a project/company/deal? I mean, I have heard people saying "I'm thinking of a Term Loan, or a Mezz Finance, or a Secured Senior Notes, Unsecured Bonds, Reedemable Preferred Shares, etc"...bla bla bla...

But at the end of the day, having all these different types and forms, when you are analysing or have to suggest one debt instrument, what are the things you analyze or use to define an appropriate form of debt?
Any sources or materials on the web??

I haven't had too much exposure to the debt side yet, that's why I am curious about that.

I appreciate your contribution.
Thanks.

 

Well if you look at the definition and attributes of all the types of debt you mentioned, coupled with debtor as well as creditor interests, you should come up with your own answer. Think about why someone would issue secured vs unsecured debt (not only from a debtor perspective) or what the advantages of redeemable preferred shares are.

 
Best Response

Good question. It took me a while to understand the concept behind different types of debt and equity financing. From a firm's perspective, it would rather have as much unsecured debt as possible. Think about it, why would you want to colladerize your inventory, AR's, Fixed Assets, etc? However, getting creditors/investors to lend you money without any tangible backing (besides covenants), means that you have to at least be an investment grade firm.

Also, a firm has to consider it's current capital structure. Although debt is generally cheaper to aquire than equity, a firm may not have enough money to cover its interest payments year-over-year. When you get into the specifics of bond-offerings, term loans, revolvers, ABL, and other debt instruments, a firm generally analyzes a bunch of things.

For example, now we are seeing a lot of firms entering into interest rate swaps since rates are so low (thanks bernake). Or it may issue bonds instead of a term loan due to the strict covenants. Or instead of issuing common equity where an investor may require a high expected return (think CAPM), they may issue preffered shares with warrants, so it is not so "ëxpensive"

 

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