Traditionally, the acquisitions of shares of Finnish limited liability companies or business assets of such companies have been financed by funds raised in a form of senior loans granted against sufficient collateral for example a mortgage on a real estate owned by the borrower). Alternatively funds have been raised in connection with an issue of shares or other securities by the purchasing company or by a directed issue of the purchaser's shares to the seller. Such means of financing and actions required for the raising of funds are governed by various laws, including the Companies Act and the Act on Promissory Notes.
Recently, certain new and more innovative financing instruments have gained popularity in Finland. This has mainly been the result of the use of such instruments in more mature financial markets. These instruments fall predominantly in the category of what one could call mezzanine instruments in Finland.
Mezzanine instruments are used in Finland as a result of increasing number of management buy-outs, other M & A transactions and restructurings of the operations of large and medium size companies. Normally the need for mezzanine financing arises when a company does not have sufficient collateral for senior lending or an increase of the equity capital is not possible or feasible as a result of e.g. the owners goal not to dilute their present ownership in a company. Mezzanine financing is, naturally, often used in addition to more traditional financing instruments.
2. Main features of mezzanine financing
Although mezzanine-financing contains characteristics from both equity and debt financing, mezzanine instruments are considered debt-instruments for Finnish purposes. Mezzanine instruments can, however, be placed into the area in between of the equity capital and current liabilities of a company, at least in the following respects:
a) the order of priority of a receivable of a holder of a mezzanine instrument is in case of a bankruptcy of a debtor company second to claims of holders of senior loans but prior to claims of holders of equity capital; and
b) in reflection of risk related to a mezzanine financing the provider of financing in the form of a mezzanine instrument typically expects a higher return than a senior lender but lower return than an equity capital investor.
The mezzanine financing commonly granted is granted in the form of a loan providing an interest rate connected, wholly or partly, to the financial performance of the company. Typically, a mezzanine loan is granted for 3-7 years but in many cases such a loan is repaid prior to its original maturity as a result of, for example, listing of the shares of the borrower.
Mezzanine financing does not, as a main rule, contain traditional collateral securing the fulfillment of the obligations of the borrower. Since mezzanine financing is based on a lender's analysis of the prospects of the borrower to produce sufficient cashflow to repay the debt, mezzanine loan documentation typically contains financial covenants.
Finnish financial institutions have started to use such covenants in their loan documention only recently. Finnish legislation does not restrict the use of the financial covenants. The covenants may, however, under certain circumstances constitute a closer relation between the lender and the borrower than is the case with a traditional senior lending. This article does not discuss lender liability issues which should be taken into consideration in connection with all types of lending.
3. Mezzanine-instruments used in Finland
One of the main advantages of the mezzanine financing is the possibility to retail the instrument for each individual situation. Certain more or less standardized instruments have, however, already been used in the Finnish market, such as:
- debentures, which may also be in the form of a convertible loan or a bond loan with warrants; and
- subordinated loans or capital loans which may also be in the form of a convertible loan or a bond loan with warrants.
3.1 Debentures
Debentures are bonds the holders of which are entitled to receive a dividend in a bankruptcy of the borrower only after the claims of the holders of senior debt have been repaid in full. The issuer of the debenture or an entity which belongs to the same group, as provided by the Finnish legislation, may not provide a collateral securing the repayment of the debenture. Debentures are governed by the Act on Promissory Notes .
3.2 Subordinated loans
As mentioned above, there is presently no legislation on subordinated loans in Finland. Such loans have, however, gained increasing popularity during the 1990's, particularly in connection with statutory or voluntary reorganizations of companies especially as a subordinated loan would be included in the equity capital when the adequacy of it has been evaluated in connection with a forced liquiditation.
In spite of the lack of legislation on subordinated loans, certain precedents, particularly issued in connection with the tax treatment of such loans have provided an effective framework for the main terms of subordinated loans as well as the accounting and tax treatment of them.
Although the present accounting and tax regulations provide that a subordinated loan forms a part of the debt obligations of the borrower, subordinated loans have been taken into account as equity for purposes of forced liquidation (subject to such subordinated loans fulfilling the requirements).
A Government Bill on the reform of the Companies Act containing, for example, proposed detailed legislation on subordinated loans, or capital loans, was issued to the Finnish Parliament in May, 1996 and approved by the Parliament in December 16, 1996. The reform will probably be in force form in September 1, 1997.
According to the Bill, a capital loan may be repaid only if the restricted equity capital and other undistributable items are fully covered after the repayment. The conditions must be shown by the borrower's audited and adopted balance sheet and the borrower's group's audited and adopted consolidated balance sheet of the last accounting period which has ended prior to the repayment.
The Bill also provides that the interest on such a loan may be paid only if and to the extent that such an amount of interest could be used and such funds are available for the payment of a dividend. The borrower and lender may agree that such unpaid interest may accumulate.
The Bill further provides that the borrower or any other company which belongs to the same group of companies is not entitled to provide a collateral securing the repayment of the capital loan. According to the proposed legislation, a capital loan shall be listed in the balance sheet of the borrower as a separate item under the equity capital. It should be noted that certain issues related to the accounting and tax treatment of capital loans remain unanswered even after the entering into force of the amended Companies Act.
The Government Bill also contains certain other amendments which shall be discussed more in detail below in Section 4.
3.3 Convertible bonds and bond loans with warrants
As mezzanine instrument, for example a subordinated loan, may contain elements of a convertible promissory note loan or a bond loan with warrants. Such loans are presently governed by the Companies Act. The Government Bill on the amendment of the Companies Act proposes certain changes to the present legislation.
3.4 Loans having an interest rate connected to the financial performance of the borrower
Finnish banks have issued loans having an interest rate which is, wholly or partly, connected to the financial performance of the borrower. Such terms are not in conflict with the provisions of Finnish legislation. It should, however, be noted that such interest rate clauses may cause, for example, tax problems (hidden payment of dividend if provided by parent companies).
4. Present and proposed legislation on mezzanine financing
Although the Finnish company, tax and accounting legislation does not define mezzanine financing or provide a sufficient legal framework for mezzanine loans certain minimum requirements have been developed through case law for the documentation of mezzanine loans which principally all lenders providing mezzanine financing have adopted.
The order of priority in a bankruptcy among the various mezzanine-instruments has not been defined by Finnish legislation. According to the present case law, the holders of debentures are in the order of priority in a more senior position than the holders of subordinated loans. Ultimately, the terms and conditions rather than the name of each individual mezzanine-instrument must be scrutinized when the nature of each instrument is evaluated in connection with deciding on the order of priority among various financing instruments in a bankruptcy process.
The Government Bill also introduces legislation on preference shares as an other means to obtain financing to the Company. According to the Bill, the holders of such shares would have a right to vote in a shareholders meeting only in connection with certain matters, as listed in the Bill, but such shares would provide a better right to receive a dividend than the ordinary shares of a company provide. The contemplated legislation also contains a company's right to issue warrants without connecting them to the issuance of a bond loan with warrants.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
