Toggle Note
What Is a Toggle Note?
A toggle note is a type of payment-in-kind (PIK) bond in which the issuer has the option to concede an interest payment by agreeing to pay an increased coupon later on. With toggle notes, all deferred payments must be settled by the bond's maturity.
How Toggle Notes Work
A traditional bond or note is a debt instrument issued by firms for the purpose of raising money to satisfy short-term debt obligations or finance long-term capital undertakings. To remunerate investors for lending their funds to the issuer for a while, the issuer pays interest or coupons to the investors. The coupon payments are made periodically and act as the rate of return for investing in these securities. At the point when an issuer encounters cash flow hardships, it could default on its interest payments, causing investors to lose future income and, surprisingly, their principal investment.
Nonetheless, companies with brief cash flow issues can include a toggle clause at the hour of bond issuance to guarantee that a skipped payment isn't ordered as a default. A bond with this feature is alluded to as a toggle note. A toggle note is a loan agreement that permits a borrower to pay higher interest later on in return for deferring interest payments now. Along these lines, toggle notes give firms a method for raising debt while staying above water during times of strained cash flow, and without defaulting. At the point when cash is at a minimum, the firm can utilize the toggle to concede an interest payment. In lieu of a payment in cash, this means the interest will, in effect, be paid for by incurring extra debt, frequently at a higher rate of interest.
For instance, in the event that a company decides to concede paying interest until the bond develops, its interest on the debt might be stated to increase from 7.8% to 9.1%.
Special Considerations
With toggle notes, a company might decide to make interest payments either in cash or by payment-in-kind (PIK), like by extra notes and bonds, and during the term of the loan, the borrower can alternate ever changing between the two forms of interest payments within certain boundaries.
Toggle notes are utilized most usually by private equity firms involved in leveraged buyouts. On the off chance that the purchase price of the target company surpasses leverage levels up to which lenders are willing to give a loan, or on the other hand assuming there is no cash flow accessible to service a loan, a toggle note will be utilized to finance the acquisition.
While this appears as though an appealing option for a firm, it includes some major disadvantages. The increased interest rate gives adequate incentive to not miss an interest payment as borrowers, in the end, could find they have even more debt than arranged on the off chance that the credit cycle turns. In effect, toggle notes are a costly, high-risk financing instrument which could leave lenders with immense losses assuming that the borrower can't pay back the loan. Accordingly, lenders give investing preference to borrowers with strong growth potential.
Features
- The toggle clause permits borrowers to maintain their bond contracts even in periods when cash available is in short supply, with the guarantee to make it up later.
- A toggle note permits the issuer of a payment-in-kind bond to concede periodic interest payments in lieu of offering a higher coupon later on.
- This type of note is most frequently found in private equity or leveraged buyout financing, where cash flows are anticipated to fill in the mid-to longer-term.
