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Lenders' and Investors' Restrictions in respect of Distribution of Profits

Use of Resources - Lenders' and Investors' Restrictions

As well as a company's internal rules (i.e. the Articles of Association) your company will make contractual commitments to those who invest in it or lend it money. Such arrangements will restrict the directors' power to dispose of surplus resources as they see fit. In addition, you may wish to consider early repayment of investors and lenders as a use for surplus revenue, although their documentation may again restrict you in this respect.

Investors: A capital investor is likely to require in a subscription agreement that a series of specified matters should be subject to his prior approval.

In the case of a joint venture company governed by a shareholders' agreement certain issues may only be approved if both or all participants agree.

A parent company may also impose similar obligations on directors of subsidiary companies.

A preference shareholder will also have certain entitlements as to dividends, which will have to be taken into account.

With the repayment of capital investors, it may suit you to repay or buy back all or part of their investment early and the same considerations apply to repayment of borrowings (see below). In addition, some investors may be willing to adjust their valuation criteria if they receive early repayment as this obviously improves their rate of return. However, development capital investors often do not welcome early repayment as they want a higher return over a longer period than they might achieve if they are bought out early. The price of early repayment may accordingly be disproportionately higher.

Lenders: In respect of loans (e.g. from banks) the terms of the loan documentation will contain provisions which will restrict your freedom to use surplus resources. As to the repayment of such loans, you may well wish to use surplus revenue generated from your operations to repay borrowing and hence reduce gearing. This in turn improves the net worth of the company and reduces exposure to interest.

Nevertheless, it does not necessarily pay to reduce borrowing at the expense of other financial needs, including shareholder dividends. You should repay borrowings which have onerous terms, but borrowings which carry relatively low interest ought not to be repaid early unless you cannot find a better use for the money (i.e. you cannot achieve a return on the cash which is better than the rate of interest on the borrowings).

A record should be maintained of all restrictions which may be imposed on your use of revenue, physical assets, book debts etc. to ensure that such restrictions are not contravened inadvertently.

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