Analyzing your business loan agreement
loan agreements will never make the best-seller list. They're filled
with jargon and legalese.
But it pays to read loan fine print to avoid unnecessary
costs and to ensure that you know what you're getting your business,
and yourself, into when you sign on the dotted line.
Eva Rosenberg, a tax preparer and owner of the Tax
Mama Web site, recalls a client who took out a loan to finance
a restaurant. Her personal assets guaranteed the eatery loan.
The restaurateur subsequently decided to sell her
condo to make an installment on some land she owned and buy another
place while she waited to build a home on the land. Her lender told
her she could. The business loan agreement with its personal
guarantee clause, however, said otherwise.
Because Rosenberg's client relied on a verbal OK instead
of knowing exactly what her business loan allowed, she watched the
bank take all the condo sale proceeds to pay off the restaurant
The lesson: Don't listen to what anybody tells you
about your loan; read the actual paperwork.
Here's what to look for:
Interest rate: Have
your banker show you how the interest is calculated, whether it's
based on prime or LIBOR (London Interbank Offered Rate), and whether
the interest will fluctuate over the term of the loan. If so, you
need to know how the sliding interest rate is calculated. Also,
ask your accountant to perform similar calculations. The bottom
line: Find out the total interest that you'll be paying and, when
offered a choice between an interest rate based on Prime or LIBOR,
which would cost you the least.
Structure of the loan: Avoid
loans that are front-loaded, recommends Tax Mama Rosenberg. In this
arrangement, your company will pay all the interest upfront and
there may even be a penalty for paying it off early.
Borrower: Is it just
your company borrowing the money or are you listed as well? What
about your spouse? Banks will often try to make both the owner and
the business responsible for the loan. While that makes sense for
the lender, it can cost you your personal assets (home, car, etc.)
should your company default on the loan.
Loan guarantees: Ah,
the games that lenders and borrowers play. Lenders want to secure
as many assets as they can to ensure they'll get their money back.
Borrowers, meanwhile, want to keep loan guarantees as minimal as
possible. If you feel like a bank is making unreasonable demands,
look for another lender. Kevin Pianko, an audit partner with Richard
A. Eisner & Company LLP in New York City, has a client who needs
a loan and is carefully shopping for a loan that doesn't require
personal guarantees. So far, he has at least one proposed lender
who isn't requiring it. Follow that example and shop around.
Covenants: These are
the conditions of the loan. For example, your company may be required
to meet a certain ratio of debt to equity. If debt gets too high
compared to equity, then your company will be in default of the
loan. Make sure you can meet the covenants before you agree to the
loan, Pianko says. Also understand how often the covenants will
be examined: annually, quarterly or all the time and whether you
can handle those requirements. "You have to see how restrictive
the covenants are and whether you can work with them," Pianko
you commit to a loan, find out if the loan is assumable; that is,
if you sell the business, can the new owner take over the loan?
Loan assumability can make your small business more attractive to
a buyer since it will cost less and be easier to take on the existing
loan rather than to get a new one, says Mike Smith, general manager
of Banther Consulting, a business consulting firm in Tarpon Springs,
Although more common in credit card agreements, these can crop up
in regular bank loans. "They allow the lender to raise the
rate based on certain circumstances, most notably based on late
payment," says Smith, a former bank officer.
Extraction clauses: Although
more common with credit card agreements, extraction clauses can
find their way into business loan agreements. They allow the lender
to raise the interest rate based on late payment or other loan violations.
Fees: These can include
charges for processing, document prep, inspection, etc. "I
haven't seen a fee yet, that can't be negotiated," Pianko says.
"Some fees are reasonable and some are not." Pianko currently
is negotiating with a lender on behalf of one of his clients. The
bank wants to charge $7,500 in facility fees. Pianko doesn't think
he can negotiate the abolishment of all fees, but he believes he
can get it reduced to $5,000.
Other conditions: Lenders
will usually require your business to maintain its operating accounts
with them or to take on other bank products. Nothing wrong with
that, but try to use your business with the bank to drive down the
interest rate or at least get some free bank services.
By scrutinizing these fine-print conditions, you'll
have a clearer sense of your, and your company's, obligations. And
the details will help you determine whether to sign on the dotted
line or find another lender fast.
Jenny C. McCune is a contributing
editor based in Montana.
-- Posted: June 26, 2002