Control by noteholders: Overview, definition, and example
What is control by noteholders?
Control by noteholders refers to the ability of those who hold a company’s debt securities (such as bonds or promissory notes) to influence or control certain decisions or actions within the company. Noteholders may gain this control through specific provisions in the terms of the debt agreement that give them voting rights, approval power, or decision-making authority over key company actions. For example, a noteholder might be granted the right to approve a company’s major financial decisions, such as mergers, acquisitions, or significant capital expenditures, depending on the terms of the notes.
For example, if a business issues bonds to raise capital, the noteholders (bondholders) may have a say in certain financial decisions or even the ability to force the company to make specific changes if the company fails to meet its obligations under the bond agreement.
Why is control by noteholders important?
Control by noteholders is important because it gives those who provide capital to the company (through debt financing) a level of influence over the company’s management and strategic decisions. This influence helps protect their investment by ensuring that the company operates in a way that can generate the revenue necessary to meet its debt obligations.
For SMBs, understanding the implications of control by noteholders is crucial when raising funds through debt financing. It’s important to balance the need for capital with the potential for giving noteholders too much influence over company decisions, which might conflict with the interests of equity shareholders or management.
Understanding control by noteholders through an example
Imagine your small business raises capital by issuing $1 million in bonds to investors. The terms of the bond agreement allow the noteholders to approve any significant changes in the company’s strategy, such as taking on more debt or selling key assets. If your business wants to take on a new loan, you would need approval from the noteholders before proceeding, as they have control over the decision-making due to the terms of the bond agreement.
In another example, if the company defaults on its debt, the noteholders might have the power to call for the liquidation of the company or take control of key assets to recover their investment.
An example of control by noteholders in action
Here’s how control by noteholders might be referenced in a bond or loan agreement:
“In the event of a significant financial transaction, such as a merger or acquisition, the company agrees that such actions must be approved by a majority of the noteholders. If the company defaults on its payment obligations, the noteholders will have the right to exercise control over the company’s assets to recover the outstanding debt.”
Conclusion
Control by noteholders refers to the influence or decision-making power that debt holders may have over a company’s actions, based on the terms of their debt agreements. For SMBs, it’s important to understand how issuing debt can lead to noteholders gaining control over certain decisions. Balancing the need for debt financing with the potential for external control is key to ensuring the company’s long-term strategy and ownership structure align with its goals.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.