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term loans

Direct business loans of, typically, one to five years.

private placements

Loans, usually long-term in nature, provided directly by a limited number of investors.

1. A direct long-term loan avoids the cost of Securities and Exchange Commission registration.

2. Direct placement is likely to have more restrictive covenants.

3. It is easier to renegotiate a term loan or a private placement in the event of a default. It is harder to renegotiate a public issue because hundreds of holders are usually involved.

4. Life insurance companies and pension funds dominate the private-placement segment of the bond market. Commercial banks are significant participants in the term-loan market.

5. The costs of distributing bonds are lower in the private market.

The interest rates on term loans and private placements are usually higher than those on an equivalent public issue. This difference reflects the trade-off between a higher interest rate and more flexible arrangements in the event of financial distress, as well as the lower costs associated with private placements.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VI. Cost of Capital and Long-Term Financial Policy

16. Raising Capital

© The McGraw-Hill Companies, 2002

PART SIX Cost of Capital and Long-Term Financial Policy

An additional, and very important, consideration is that the flotation costs associated with selling debt are much less than the comparable costs associated with selling equity.

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