Debt financing offers business owners a strategic avenue to secure capital for growth, operations, or expansion by borrowing funds from lenders. Unlike equity financing, which involves giving up ownership stakes, debt financing allows businesses to maintain complete control while accessing necessary funds. Whether through traditional bank loans, lines of credit, or bonds, this method provides flexibility in repayment terms and interest rates tailored to the company’s financial needs. This blog will highlight the important concepts and transactions involved in debt financing.

The Basics of Debt Financing

In essence, debt financing is where a party, typically referred to as a creditor, provides financing to another party, the debtor. The debtor must repay the funding to the creditor through specific terms agreed to between them.

The debt may be secured or unsecured. Secured debt is backed by collateral, which is an asset pledged by the debtor to the creditor as security against the loan. If the debtor defaults, the creditor can seize the collateral to recover the outstanding debt. Common examples include mortgages (where the home serves as collateral) and auto loans (where the vehicle is collateral). Unsecured debt, on the other hand, does not require collateral. Instead, creditors rely solely on the debtor’s creditworthiness and promise to repay. Examples include credit cards, personal loans, and student loans.

The Initial Agreement Between the Parties

The process typically begins with the debtor agreeing to provide financing to the creditor under the terms and conditions offered in an initial agreement. The style and form of this letter can vary and can be named a commitment letter, an offer to finance, a term sheet, and more. However, such an agreement generally contains the following features:

• The types of financial accommodations offered to the debtor and the rate of interest applicable;
• The type of credit or credit facilities which provide access to funds through options such as lines of credit, credit cards, overdrafts, term loans, and trade finance;
• The maximum credit available per credit facility;
• Repayment terms, including a maturity date for the loan;
• The fees associated with using the debtor’s services; and
• The security required for the loan.

A loan agreement often replaces the commitment letter, and together, they form the entirety of the debt financing terms and conditions.

Common Financial Accommodations

There are many ways in which to structure a loan agreement. The following are several options generally available to debtors:

Direct Loan

A direct loan is a financing arrangement where funds are borrowed directly from a creditor without intermediaries, and the debtor pays the principal of the loan, plus interest, directly to the creditor. A direct loan can be provided in any currency. Still, it is important to note that in the event of default or breach of the loan agreement, the courts of Canada are limited to awarding judgements in Canadian currency.

Direct loans are typically offered as a demand loan, where the creditor can demand repayment at any time, or a term loan, where the loan is provided for a specified period of time, and the repayment obligations trigger in the event of a default or after the maturity date. In terms of repayment, the loan agreement can specify that payments must be made regularly and periodically and can be prepaid on certain terms and conditions.

Depending on the parties’ needs, a loan agreement can be evidenced by a promissory note, which is a debtor’s promise to repay funds to a creditor on certain terms. They can also be structured on a demand or term basis.

Letters of Credit

A letter of credit is issued by a creditor, typically a bank, guaranteeing that a seller will receive payment from a buyer upon meeting specified conditions. The purpose of a letter of credit is to secure payment obligations to the beneficiary of the transaction. These instruments are typically used in international transactions. The lending bank will typically have a reimbursement agreement with the debtor, who will sometimes provide security to the bank in case the beneficiary calls the letter of credit.

Bank Guarantees

The Bank Act allows chartered banks to guarantee the payment of funds. They work similarly to a letter of credit except that the beneficiary of the guarantee cannot demand payment unless the debtor has defaulted on their repayment obligations.

Enforcement in the Event of Default

If a debtor fails to repay the loan per the terms and conditions agreed to by the parties, the debtor may enforce the repayment. This can be done by the terms of the agreement or through various mechanisms afforded by law. The success of enforcing a debt depends on the creditor’s priority in repayment, which is determined by whether the debt was secured or unsecured and whether the secured creditors had registered and perfected the security. We have previously written about the priority of repayment between creditors.

Even so, creditors may obtain judgments to enforce repayment, which could involve writtenor asset seizure, and bankruptcy proceedings provide relief for debtors unable to meet obligations. However, creditors may receive only partial repayment.

To understand your options when trying to repay loan obligations, it is important to consult with an experienced corporate lawyer.

Contact the Business Lawyers at Bader Law for Advice on Corporate Financing

At Bader Law, our business lawyers help clients access new capital while maintaining control of their business and minimizing legal risk. We also work with clients to organize their business, manage information technology and licensing, and effectively address shareholder disputes that may arise. We work diligently to help our clients optimize their business by choosing the best structure and legal composition for their operation. Contact us online or at (289) 652-9092 to schedule a consultation with one of our talented corporate lawyers.

In the realm of financial transactions, the concept of priority holds significant sway over the protections afforded to various stakeholders and the remedies available to them at law. The importance of securing one’s position in the creditor hierarchy cannot be overstated. As a business owner, it is crucial to understand the intricacies of creditor rankings and the importance of perfecting a security interest, as these concepts can make or break your venture.

The Importance of Security in Ontario’s Legislative Framework

The Personal Property Security Act (“PPSA”) is an Ontario statute that governs the security interests of personal property (otherwise known as movable property), which are not fixed to land or real estate. It establishes a system for registering and prioritizing these interests, providing clarity and protection for lenders and borrowers in case of default or insolvency.

Generally, the PPSA provides that a lender and other creditors can obtain priority over other creditors against a debtor by obtaining security. This security can be over specific assets, such as a vehicle or all of the debtor’s personal and real property. Security gives a creditor certain rights against some or all of the debtor’s assets in priority to the debtor’s other creditors when the security becomes enforceable.

However, obtaining security is not enough to rank above other creditors or other entitled parties at law. The secured creditor must also take steps to “perfect” the security interest.

Perfecting a Security Interest

If the security falls under the regime governed by the Personal Property Security Act, the legislation provides the necessary procedures for perfection.

To summarize, the PPSA requires that “attachment” has occurred and either a financing statement has been registered or the secured creditor obtains possession of the collateral. Attachment refers to the process by which a security interest becomes legally enforceable against a debtor’s collateral (movable property) and other potential creditors. There are three key elements to attachment:

1. There must be an agreement between the debtor and the secured party (a written security agreement), which must be signed by the debtor and must describe the collateral;
2. The secured party must provide some value in exchange for the security interest, such as a loan; and
3. The debtor must have rights in the collateral, either through ownership or another legal right whereby the debtor has the authority to grant a security interest.

Perfecting a security interest through possession or control is also possible.

Priorities of Perfected Security Interests

The Personal Property Security Act provides a general rule that where priority is to be determined between two or more perfected security interests, the order will be determined by the first to register, not to perfect.

The PPSA also provides that where priority is to be resolved between a security interest perfected by registration, or a security interest perfected by non-registration, such as possession, the priority will be determined by the registration date, not perfection. The legislation also makes it clear that the registered perfected security interests will take priority over non-perfected or registered security interests. Additionally, the priority will generally be determined by the time and date of registration.

Nevertheless, there can be situations where the priority contest is between creditors who have either not registered their interests, or have not perfected them. In the former contest, the priority will be determined by the first to perfect their security interest, otherwise known as the “first to perfect” rule. In the latter contest, the priority will be determined by the first to attach, for example, when all three elements above are complete or satisfied.

Unperfected Security Interests

There are significant consequences for failing to perfect a security interest. In addition to ranking subordinate to creditors who have perfected their security interests in the same collateral, an unperfected security interest ranks below the following:

1. An individual or creditor with a lien granted by another statute or legal principle;
2. An individual or creditor who has the collateral seized through execution, attachment, garnishment, charging order, etc.; and
3. An individual or creditor entitled by the Creditors’ Relief Act or otherwise to participate in the distribution of the property seized through the above means.

An unperfected security interest is also largely ineffective against other individuals in bankruptcy. For example, it is ineffective against a trustee-in-bankruptcy, a transferee of chattel paper, or a transferee of other intangibles.

Exceptions to the Priority Rules

The legislation specifies that there may be exceptions to the general rules set out above, such as:

1. Purchase-Money Security Interest (“PSMI”) – A PSMI is a security interest in specific collateral that the creditor financed for a borrower’s purchase. Per the Personal Property Security Act, the PMSI will have priority over pre-existing security interests in the same collateral.
2. Fixtures and Accessions – The Personal Property Security Act provides special considerations for fixtures and accessions. For fixtures, security interests that have been attached before the goods became a fixture have priority as to the fixture over any person with an interest in the real property. For accessions, a security interest in goods that attached before the goods became an accession has priority to the accession over the interest of any person with an interest in the whole of the good. Essentially, the priority of security interests in these types of collateral is based on the first-to-attach rule, with important distinctions.
3. Investment Property – The rules regarding investment property priorities are complex as it is based on the concept of “control,” which trumps perfection for this type of collateral and rank in time compared to each other.

Contact the Corporate Lawyers at Bader Law for Trusted Advice on Corporate Finances

At Bader Law, our business lawyers provide comprehensive advice to clients seeking to safeguard their interests and minimize their exposure to legal risk. Whether you are a creditor seeking to secure your loans or a borrower aiming for clarity in your financial dealings, our experienced legal team is here to guide you through the complexities of security interests. We work with clients to organize their business, manage information technology and licensing, and effectively address shareholder disputes. We work diligently to help our clients optimize their business by choosing the best structure and legal composition for their operation. Contact us online or at (289) 652-9092 to schedule a confidential consultation.

As the number of new companies created in Canada continues to grow, so does the need for capital to fund them. This is where venture capital comes in. Venture capitalists provide funding for start-ups and early-stage businesses that are developing their products or services before they’re ready for a full-scale launch.

Though it’s not easy to get venture capital funding, it’s still something every entrepreneur should think about early on in their business planning process. This blog post provides a basic overview of venture capital funding in Canada.

What is a venture capital fund?

A venture capital fund is an investment vehicle created to empower entrepreneurs and start-ups. These funds pool money from investors, who then invest it in new businesses, helping them grow.

There are many different venture capital funds, each with its own mechanics and purposes. Some specialize in specific industries, like healthcare or technology. Others focus on particular geographic areas within a country or even the entire world.

Venture capital funds can be organized as limited partnerships (LPs), which means that investors contribute money and receive equity stakes in the fund’s companies. They also have voting rights at annual meetings and sometimes get a share of profits earned through their investments. Other venture capital funds are organized as closed-end funds (CEFs), which means they issue shares regularly to raise additional capital for new investments. However, closed-end funds don’t offer investors voting rights or other benefits (though some offer dividends).

Are venture capital funds and venture capital firms the same thing?

Simply put, venture capital firms create and oversee venture capital funds. While venture capital funds are legal entities, they are separate from venture capital firms. Venture capital firms combine a collection of legal entities that aim to generate substantial returns for their investors.

What sources do venture capital funds draw from?

It can be challenging for early-stage companies to obtain debt financing due to their lack of cash flow and collateral. For these companies, funds are typically generated from the founders themselves, who may also rely on friends and family. They may also turn to financial institutions, pension funds, or the government. However, funds may be required above what can be generated within the founders’ network. That’s where angel investors come into play.

Angel investors are a type of investor. They fund start-ups and other business ventures in exchange for equity or partial ownership. Angel investors may be wealthy individuals or family offices (as opposed to venture capital funds) willing to invest their own money into companies they believe in.

While the term “angel investor” is sometimes used interchangeably with “seed investor,” the two terms do not mean the same thing. A seed investor is someone who provides the first round of funding for a start-up, after which the start-up may seek additional financing from angel investors or venture capital funds.

What types of venture capital funds exist in Canada?

The varying types of Canadian venture capital funds serve to meet the different needs of start-ups. Five types of venture capital funds are:

1. Private independent venture funds: These funds are professionally managed through pension funds, insurance companies, and other investors (such as high-net-worth individuals).
2. Government-sponsored venture funds: These funds are operated by institutions owned by the Government of Canada; for example, the Business Development Bank of Canada (BDC).
3. Corporate-sponsored venture funds: These funds invest in and support start-up companies that can contribute strategically to their corporate sponsors.
4. Institutionally operated venture funds: These funds are operated by institutions such as banks and Canadian pension funds.
5. Labour-sponsored venture capital corporations: These are a type of mutual fund corporation that is sponsored by a labour union. The corporation invests in venture capital funds focused on small and medium-sized enterprises.

What laws affect the venture capital industry?

The venture capital business comes with benefits and certain legal exemptions for those who engage in it. For instance, because most venture capital funds in Canada are structured as limited partnerships, they are not taxed as separate entities. Instead, they are considered vehicles through which funds flow. An exemption to this tax perk is that if any partners are non-residents of Canada, sums paid to those individuals may still be subject to Canadian withholding tax.

If a venture capital fund seeks to issue securities to raise funds in Canada, it will be bound by federal and provincial securities laws. National Instrument 31-103, a national securities regulatory requirement, applies to all firms trading in or advising on investment funds. It requires that promoters, managers, and principals of the venture capital fund:

• Register as a dealer if they are trading in securities;
• Register as an adviser if they are advising others on the investment or purchase of securities; or
• Register as an investment fund manager if directing the business operations and affairs of the venture capital fund.

Multiple registrations may be needed if the individual engages in more than one of these activities. However, it is often the case that the venture capital fund manager and the fund itself need not register as either advisers or dealers if they do not engage in the above activities of trading and advising on securities. It is always good to consult with a legal professional regarding your potential rights and obligations at law when engaging with venture capital funds.

Contact the Mississauga Lawyers at Bader Law for Corporate Finance Advice on Corporate Finance for Your Start-Up

At Bader Law, our experience allows clients to access new capital while maintaining control of their business and minimizing legal risk. We also work with clients to organize their business, manage information technology and licensing, and effectively address shareholder disputes that may arise. We work diligently to help our clients optimize their business by choosing the best structure and legal composition for their operation. Contact us online or at (289) 652-9092 to schedule a consultation with one of our talented business lawyers.