Financial Obligation: Everything You Need to Know
The contractual promise to make payments and/or pay a debt in full is known as a legal, financial obligation.3 min read
The contractual promise to make payments and/or pay a debt in full is known as a legal, financial obligation. In finance, this often involves making specified payments by specified dates and/or holding a company responsible for meeting established performance requirements.
Any outstanding debts or regular payments that you must make are considered financial obligations.
What are the Requirements for a Financial Obligation?
Any form of money can represent a financial obligation – coins, bank notes, or bonds are financial promises that you will be credited the current value of the item. Financial agreements, like loans, are contractual agreements to make installments on a sum until it is fulfilled, as well as interest.
Borrowers are under obligation to make payments proportionate to a given timeline.
In the case that a company is a borrower, they may have to disclose the financial obligation to the Securities and Exchange Commission (SEC).
A board may be under an obligation to pay an executive a certain amount of money upon reaching certain goals, and a lender may have to charge a certain percentage of loan interest for a specific length of time, which is known as a fixed rate.
What are the Consequences of Unfulfilled Financial Obligations?
With so many obligations to keep up with, lack of fulfillment, whether intentional or unintentional, can have serious negative impacts on both parties involved. Not fulfilling these financial obligations may give the lender the right to seek recourse in court.
Guidelines for Financial Obligations
The features of an obligation are as follows:
- Held by an individual or entity.
- Written or unwritten.
The Federal Reserve determines the financial obligation ratio in the United States, and that ration is the ratio of household debt payments to total disposable income. The financial obligation ratio is the ratio of household debt payments to total disposable income in the United States and is produced by the Federal Reserve. It measures how much household income is being spent on repaying debts and other financial obligations.
This FOR is released quarterly by the Federal Reserve Board and is a very useful tool in determining individual budgets.
Over the years, the financial obligations of American households will change based on variations in debt, income, and interest rates. A higher FOR will increase any risk that households will not be able to meet financial obligations.
Requirements for Corporate Acquisitions in Regard to Financial Obligations
It can be noted that there are two types of acquisitions related to financial obligations:
- Wholesale acquisition of all of the common stock of a company.
- Acquisition of a company's assets.
This is not to be confused with an instance of a party acquiring the controlling interest of a company, but not obtaining all of its stock.
When you obtain all of a company's stock, you now own that corporation including:
- Sales and support agreements.
- Employment agreements.
- Prior actions - known and unknown.
- Stock plans and their governance.
This is a last resort for some cases and is not uncommon in venture capital financed companies. Usually, those who were the last to invest money get their money back, then the next, and so on.
For some individual contributors, this means a big return. In the case of employees who have "cliff vesting on change of control" clauses in their option plans, any and all unvested stock is instantly vested. For others, what is vested is what they will get in return.
In times of a stressful acquisition, a partial return is received on any shares vested. When this happens, money runs out before common stockholders are paid, and those involved in the company get absolutely no return.
An outright acquisition is usually the most undesired outcome of a failed financial obligation, which leads to an "asset purchase," which is when a company sells a certain asset to the buyer for a fixed sum. This may also include employee contracts, when transferable.
In the case of some large acquisitions, the value of certain assets is lost, when an employee who knows of the assets is no longer with the company, or it isn't inventoried.
Sometimes, cash is used to restructure or liquidate a company, and some of the larger shareholders will eventually see a return. It is wise to have a plan and funds in place so that in the case of an acquisition, your company will be able to fulfill its financial obligations.
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