What are loan notes?

Paul Sutton

What are loan notes?

Loan notes are commonly used for raising funds for a wide range of purposes, including institutional investments, securitisations, property development projects, public companies, owner-managed businesses and start-ups. They are also commonly used for restructuring existing businesses. They are extremely scaleable, and in theory there is no limit to the total amount that can be raised, or the number of note holders.

So what exactly are they?

The concept is very simple. A loan note is essentially just an IOU – a piece of paper recording a promise to repay a loan, usually with interest, on specified terms. They are an effective way of recording loans from multiple lenders on the same terms. Loan notes may be:

  • Secured or unsecured
  • Listed on a stock exchange, or unlisted
  • Transferable or not transferable

However, the terminology around loan notes can be confusing. And by the way, “bond” and “loan note” often mean the same thing.

The “issuer” is the borrower under the loan notes. This is often a company – for example, a member of an existing trading group, or a new company established for a specific project.

The “loan note instrument” is the document which sets out the terms and conditions relating to the loan notes. It is signed by the issuer, and is addressed to the world at large. The loan note instrument contains schedules which include the commercial terms of the loan and the procedures for holding meetings of note holders.

The “note holders” or “subscribers” are the lenders – the people or legal entities who have agreed to lend money to the issuer by subscribing for loan notes. Sometimes, loan notes are issued to record the terms of an existing debt which is outstanding between issuer and subscriber.

The “loan note certificate” is like a share certificate. It is usually a one or two page document, and is signed by the issuer and given to each note holder. It constitutes formal evidence of the debt. Each loan note certificate will set out the names of the issuer and the holder, the date of issue, the maturity date, the interest rate and the amount of loan notes held. And it will attach the terms and conditions relating to the loan notes.

Coupon” is another word for interest. This can be fixed or variable, and it may be paid during the life of the loan, or “rolled up” and paid at the end.

The “maturity date” is the date on which the loan notes are to be repaid. The year of maturity is usually shown on the front of the loan note instrument and on the face of each loan note certificate.

Redemption” means repayment of a loan note – in other words, when the issuer pays all outstanding principal and interest, and the loan note is cancelled.

A “convertible” loan note is one that can be exchanged for shares in the capital of the issuer. The relevant loan note instrument will set out when this exchange is triggered (for example, at the option of the note holder or the issuer), what kind of shares are to be issued, and how the number of shares to be issued is calculated.

The regulatory and tax status of loan notes depends very much on the circumstances involved. Detailed rules govern who loan notes can be offered to, what information must be supplied, and who can be involved in promoting them, advising on them or arranging investments in them. These rules also dictate what kind of financial services professionals need to be involved in the offering of loan notes or the operation of structures involving loan notes.