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Why transparency is important when raising debt capital

Feb 25, 2021 | Blog

For many companies, debt capital aka debt funding is a necessary part of their financial structure. Debt capital involves borrowing money from a bank or other lender, usually in the form of loans, corporate paper or by issuing a bond and then having to pay the full amount back with interest. Together with equity financing, debt capital is a way for companies to fund operations, expand their business, venture into new markets or locations, invest in research and development, or buy assets. When it comes to debt, something to bear in mind is the amount of interest being charged on these loans and how this might compare to the cost of equity financing. In most cases it is cheaper to issue debt than raise equity. However, the key difference is that debt must be repaid in future together with interest regardless of the corporate’s performance. This leads us to why transparency is crucial when raising debt capital, both from the lender or funder and from the corporate taking on the debt obligation. 

What do we mean by transparency? 

First things first, let’s take a look at what we mean by transparency in the context of financial statements. In this context, the word “transparency” often refers to high-quality financial statements that are clear and easy to understand. Let’s use this in a real-world example to illustrate its importance. Company A and Company B are both looking to raise debt capital for similar reasons in the same industry. Let’s assume that both companies have the same earnings growth rate and similar returns on capital. The only difference is that Company A is a single business with straightforward and easy to understand financial statements, which explains everything openly. At the same time, Company B has multiple companies and subsidiaries with complex financials that are unclear and leave gaps. A funder would likely be more favourable to Company A because less information and less clarity simply mean less certainty for investors. Funders need to be sure about a company’s financials, including where they are spending their resources and how they are making money, to accurately analyse the transaction and work out the exact risk involved. 

Full understanding

Ensuring that a corporate understands the transaction’s full cost is crucial and is another fundamental reason why transparency around the terms of engagement is required. All too often, lengthy debt agreements and jargon can be confusing and leave corporates unsure of the exact costs and requirements involved. Whether a corporation is raising debt capital for the first time or the fiftieth time, there must be full transparency between the corporate and the lender regarding the obligations that fall on both parties, including the finance charges/interest. This is also in the funder’s interest, as a corporate that is not adequately informed is more likely to require a waiver or amendment to the original agreement further down the road when it comes to debt repayment. 

Gaining trust

From the funder’s point of view, a corporate should disclose as much information as possible so that the funder can feel comfortable knowing that the debt will be repaid as agreed. The more transparent the two parties can be upfront, the better for everyone. Once trust is established between the funder and the corporate, they are in a better place to tackle any obstacles along the way which may change either party’s circumstances, such as a global pandemic. This trust building starts when a funder can accurately and easily analyse the financials of the corporate to get the full picture of the corporate’s financials and ability to service the debt. However, the transparency should continue after the deal has been made as well, in order to keep the funder adequately informed along the way. A debt funder should be seen as a partner in your business with a vested interest in your success and trust is integral to any successful partnership.

Accountability

Full transparency from both funders and corporates allows each party to be held accountable for holding up their end of the transaction. For example, when a global pandemic comes around, full transparency from a corporate can help a funder to feel more comfortable with what this shock might mean for them and how it will impact their ability to continue to service their debt. Transparency means the funder is more likely to work with the corporate to make sure the agreement is upheld, even if it is adjusted along the way. Part of this transparency includes engaging directly and frequently, particularly during a riskier climate. So, while upfront transparency is essential, transparency along the path is just as important to keep each party up to date. 

6 ways to achieve transparency

Addendum’s Funding Solutions Platform helps corporates review and assess a wide number of potential funders to the company on standardised terms that are fair and balanced to both sides. At Addendum, we have made use of various strategies to promote transparency in our Funding Solutions Platform because transparency is at the core of our principles.  Here are 6 of the most important tools we have used in our Funding Solutions platform to promote transparency for all parties involved: 

  1. Automation: We believe in using technology to automate processes to save time and effort, so our funding platform makes use of proprietary technology to make processes more efficient. For example, the “request meeting” action button, which automates the process of setting up a meeting between the lender and the corporate, making it quicker and easier.

     

  2. Centralised information: We encourage full transparency between corporates and all funders. Corporates have one centralised document folder to which all funders have access so that they can all see the same information. If a single funder requests anything over and above what is provided, the rest of the funders will also be able to see this information once it has been added to the folder.

     

  3. Feedback: Transparency is carried throughout the transaction process and onto the post-deal feedback. This means that any funder who might be unsuccessful in their attempt to fund a corporate are given a summary of which pricing levels were accepted and in what size. This is important to help funders ascertain whether they were near the market’s view on the same issuer.

     

  4. Debt Utilisation Graph: This infographic ensures that any funding raised through the platform both aligns with the corporate’s internal limits and is made visible to prospective funders. In other words, a corporate’s debt limit can be set at a particular amount and locked in place and the platform will ensure that this limit is not exceeded. This maintains transparency for both parties as the funder or the corporate can navigate to the corporate section of the profile and view the outstanding debt at any time

     

  5. Direct relationship: The platform ensures transparency between the corporate and the funder by creating a relationship between the two through a bilateral legal agreement. This opens the door for direct communication and full transparency which cuts out the middleman and allows each party access to the other when they need it.

     

  6. Clear documentation: We have formulated a 23-page standardised Master Terms agreement for funders and corporates to use. By consulting with key market participants, we have made sure that the Master Terms agreement is clear and concise. It was created with the utmost transparency in mind so that funders and corporates can be fully aligned on the ins and outs of the deal. 

 

As you can see, full transparency is of the utmost importance when it comes to raising debt capital, both from lenders or funders and corporates, so that everyone is one the same page and the deal can run smoothly. If you’d like to learn more about the Addendum Funding Solutions Platform, click here

www.addendum.co.za

enquiries@addendum.co.za 

 

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