Related-Party Transactions: a Worked Example

A lender underwrites a business on what it earns from customers who could have gone elsewhere and on assets it can reach. Dealings with insiders disturb both. A sale to a family company can be priced to suit a covenant, and the invoice may not be collected on any normal timetable. Rent paid to the owner's trust takes cash out ahead of the bank. A loan to a director is an asset in the accounts and an awkward claim in practice. Each may be entirely proper, and the owners may have good reasons, but none of the figures was tested by a counterparty with an opposing interest.

Under the international standard, IAS 24 (NZ IAS 24 and AASB 124 locally), a related party includes a person who controls or significantly influences the entity, key management, close family of those people, and entities they control. FRS 102, which most UK mid-market groups use, has a similar definition and directs attention to the substance of a relationship over its legal form. Where they apply, these standards require the nature of the relationship, the amounts, the outstanding balances and their terms. They also allow a statement that dealings were on arm's-length terms only if that can be substantiated.

What a lender actually receives varies. Tier 2 reporters in New Zealand and Australia are excused some detail, chiefly the breakdown of key management pay, but still report their dealings with related parties. A smaller UK company under the FRS 102 small-entities regime has, for periods beginning on or after 1 January 2026, moved to the fuller section 33 requirement in place of a narrower one covering dealings off normal market terms. Many smaller private companies in New Zealand and Australia prepare special-purpose accounts instead, and those need not apply these standards in full. So a lender does not rely on the note. It asks for a list, and reads the debtors ledger, the creditors ledger and the rent roll for familiar names.

A family-owned olive-oil producer, constructed for this page like every figure in it, reports revenue of US$30.0m, EBITDA of US$4.5m, net debt of US$13.5m and trade debtors of US$5.5m. The lender's questions bring out four dealings. It sold US$6.0m of oil, at a 40% gross margin, to a distributor owned by the founder's son; other customers buy at 28%. That distributor owes US$2.2m. The factory is rented from a family trust for US$1.2m a year, against US$0.8m in an independent valuation. The founder's company charges a US$0.4m management fee. And the founder owes US$1.6m, up from US$0.6m, shown in other debtors.

The adjustments run both ways, and that is the discipline. The sales flatter EBITDA by a figure the lender has estimated, since a 12-point margin gap suggests a pricing difference without proving it. The rent and the fee depress EBITDA, but a lender gives credit for them only if they contractually stop, because while they continue the cash still leaves. The rent is shown here as a cost above EBITDA, as it would be in accounts or covenant definitions that keep leases off the balance sheet; where a lease is capitalised the rent sits below EBITDA, and the excess inflates the lease liability instead. The advance rate and the prices are the example's. The US$1.6m loan to the founder is the plainest item of all: it is often deducted when a lender works out tangible net worth, since its value depends on the person who chose to borrow it.

Dealings between a parent and its subsidiaries are related-party transactions too, but consolidated accounts eliminate them. The dealings that reach a lender's attention are often with companies outside the group that are owned by the same family, because those sit outside the consolidation and stay in revenue and debtors. Reading one company's accounts instead of the group's raises the problem in its strongest form.

Connected exposure is the lender's own concept, grouping borrowers it treats as one risk for limit purposes. Related-party transactions are about what passes between parties in the accounts. The same family can raise both questions in one file. Owner drawings are a third neighbour: payments taken out openly as the owner's return, where a related-party dealing may look like an ordinary business cost.

DEFINED IN ONE PARAGRAPH → · ELIGIBLE RECEIVABLES → · CONNECTED EXPOSURE →

Disclosure comes first. Owners who list the dealings before being asked have shown the lender something about how they run the business, and a late discovery reads the opposite way. Next comes the document. A facility will often require that dealings with affiliates be on arm's-length terms, restrict distributions, and subordinate loans from shareholders so that family money ranks behind the bank. Security reaches only the borrower's assets, so a factory in a family trust is outside it unless the trust gives its own. Invoice financiers commonly leave insider invoices out of the funding base, as the example shows.

The most useful question is often the simplest: what would this business look like if the relationship ended tomorrow? If the related distributor is the only route to market, or the family's factory cannot be replaced, the lender's reading of the business turns on those arrangements, and the file should say so.

HOW BANKS ASSESS MANAGEMENT → · AUDITED, REVIEWED OR COMPILED →