Debt Financing

Debt financing is taking the loan from bank, shareholders or any other person. Corporation will pay interest on this kind of loan.

Debt financing offers a great deal of certainty and consistency.

Lender’s return is limited to interest on loan.

Debt financing is quite easy. Loans from banks or other financial institutions can often be arranged in a matter of days.

Non institutional lenders can also lend money to individuals and small businesses.

A lender may require a loan to be secured against the assets of the corporation or the personal property of the incorporators, directors or shareholders.

Debt financing does not create an ownership interest in the corporation or allow the creditor to take part in the management and control of the corporation.

Equity financing

Money is raised by issuing shares.

Issuance and selling of new shares can only take place if company has authorized capital in its articles of incorporation.

In smaller corporations, if financing is provided by an outside party the sale of shares can result in a reduction or loss of ownership or control. Bringing in another shareholder may upset the balance of interests with in the corporation.

Purchasing shares gives ownership interest in the corporation and an opportunity to benefit from corporation’s growth.

If the shares being offered for sale carry voting rights, they give the purchasers a say in the control and operation of the corporation through their ability to participate in the election of directors.

Money raised by the sale of shares does not have to be paid back.

Types of Debt Financing

Unsecured Loan

With this type of loan, money is lent to borrower without any security.

Sometimes a promissory note is signed by the borrower. A promissory note will set out the amount of loan, the interest rate, the manner of repayment and any other detail of the agreement. In case of a failure by the borrower, the promissory note can be used as a basis for lawsuit.

Loan with guarantee

One or more shareholders will sign a promissory note or other agreement as personal guarantor.

In case corporation defaults, the guarantors agree that the lender will be able to look to them for collection of the debt.

Loans secured by mortgage of real property

Real property owned by the corporation can be used as security for a business loan. In a situation like this, a mortgage is signed and registered against title of the property. In case of default, the lender may enforce selling the property under power of sale.

The unsecured creditor and the judicial process

The unsecured creditor can bring a legal action against the defaulting borrower. This action is considered by filing a claim with the appropriate court. If the action is successful, the court awards judgement against the borrower. The judgment will set out damages, interest and cost to which the lender is entitled.

Personal Property Security Act

The PPSA gives the lender the right, when the loan is in default, to seize the assets against which the loan is secured and sell them. The money obtained from the sale is used first to cover the lender’s reasonable expenses in seizing and selling the assets, then to pay off the loan.

Mortgage Enforcement

There are two most common methods for enforcing the mortgage.

Power of Sale

The lender does not take title of the property but simply sells it in order to collect the amount owing on the mortgage. The lender must apply the proceeds of sale to the outstanding principal and interest under the mortgage, to the legal fee on sales, and to any other legitimate expenses he or she has incurred in enforcing the mortgage.

The lender has the right to sue the borrower if the sales brings in less than amount he or she is entitled to but if it is a surplus it must be given back to the borrower.

Foreclosure

Foreclosure is a very costly and lengthy process. In this case lender takes title of the property. When lender takes the title, he or she must pay land transfer tax on the market value of the property. If the lender sells the property and does not produce a sum large enough to cover the principal, interest and cost on the mortgage, the lender cannot pursue the borrower for shortfall. In case of surplus, lender can keep it.

Disclaimer:

This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.

References:

The fundamentals of corporate law and procedure

By Mark Walma and Patricia McCann – Smith

Publisher: Edmond Montogomery Publications Limited, Toronto, Canada.