Limited Liability Company – Loans & Investments & Share Issues
1 April 2022
Every company needs money. If the company has strong cash flows and minimal investment needs, the company can survive without any outside money. However, typically all the companies will need external financing – either in the form of loan or investment – at one point or another. This is typically because the company needs working capital or capex, needs to refinance previous commitments, is acquiring something, needs bridging or simply just wants some headroom.
A Finnish limited liability company can raise financing or get loan (or credit) in the following ways. These represent the typical ways of how money is injected into a Finnish company.
Loan. A ‘normal’ (and simple) loan is based on the agreement between the lender and debtor. The parties can relatively freely negotiate the terms and conditions of the loan, but at least the following terms should be included in the loan agreement: the amount of debt, interest, payment of interest and principal, repayment, prepayment, and maturity. In case of a more complex lending transactions, attention should be paid to loan covenants, defaults, guarantees, commitments, securitization, and syndication.
Capital loan. Capital loan (or subordinated loan) differs from a ‘normal’ loan in many aspects. The Finnish Limited Liability Companies Act sets forth certain minimum requirements that must be applied with when drafting the capital loan documents. For the loan to be categorized as a capital loan, the following provisions must be included in the terms and conditions:
the principal and interest shall be subordinated to all other debts in the liquidation and bankruptcy of the company;
the principal may be otherwise repaid and interest paid only in so far as the total sum of the unrestricted equity and all the capital loans of the company at the time of payment exceed the loss on balance sheet to be adopted for the latest financial period (or more recent financial statement); and
the company or a subsidiary shall not post security for the payment of the principal and interest.
The capital loan shall be included in the balance sheet as a separate item and shall be considered as liabilities for the purposes of accounting.
Convertible note. The convertible note is a hybrid instrument that contains elements of both debt and equity investment. Convertible note is a loan which can be converted into the company’s equity in case of certain events take place. The convertible note accrues interest and has a maturity date in case the conversion shall not take place. Setting the conversion rates and events typically requires careful consideration and some understanding of basic maths.
It is typical that the convertible note shall be construed as a capital loan within the meaning of the Finnish Limited Liability Companies Act. This means that the convertible note shall be subordinated to the claims of other creditors and that the note shall constitute an unsecured obligation of the borrower. Repayment of the convertible note can be done in accordance with the rules concerning the repayment of a capital loan.
Equity investment. The company and the investor can agree that the investor shall make a gratuitous capital investment to the company’s reserve for invested unrestricted equity. This sort of investment does not affect the share capital of the company and no trade register formalities need to be followed in this respect. Moreover, paying back the investment from the company’s reserve for invested unrestricted equity is simpler than paying it back from the share capital. The equity investment, as described in this paragraph, is relatively flexible instrument that typically only requires an investment agreement between the parties.
Share issue. The company and the investor can also agree that the investor’s capital investment shall be made against the company issuing shares to the investor. The issued shares can be either new shares or treasury shares.
Whether the investor and the company end up using debt instruments or equity depends on plethora of things, such as the risk appetite of the investor, cash flows, timeframe, return expectations, assets/collaterals, gearing, cash position of the company, default probability, credit cycle and the debt service capacity of the company. The Pecking Order Theory may also shed some light on the reasons for the selected instrument. Be that as it may, every equity and debt instrument is different and should be reflected to the case specific needs.
