July 21, 2014
Obtaining commercial business financing from any financial institution can be complicated. It requires substantial consideration of a variety of factors.
A business lender will, in virtually all instances, propose terms that are necessarily protective of its own best interests, so you, as a business borrower, must be very careful to do the same. Unfortunately, in many instances, business borrowers are lured into their decision to sign on the dotted line solely by attractive interest rates, which have for the last few years, been historically low. Basing your decision on this sole criterion can be a dangerous mistake. A number of other global factors should be carefully considered before a commitment letter is signed and delivered, as many of the terms may be negotiable.
First and foremost, of equal importance to financial considerations, should be a careful evaluation of the account officer who will be handling your credit facilities. This individual should be someone with whom you are comfortable and share an open and honest mutual respect. He or she must have both the desire and the ability to understand and care about your business. The lines of communication must be strong between you, and if you find that you are not comfortable with him or her during the loan application process, you may want to consider asking for another representative, or if necessary, consider another financial institution.
Another one of the global factors to consider is loan collateral when evaluating loan terms. Whenever possible, it is recommended that business assets, which would include items such as equipment, furniture, fixtures, inventory, accounts receivable, and related business real estate be utilized before your personal assets.
When discussing any necessary pledging of personal assets as part of a financing package, you should also discuss and negotiate the possibility of marshaling. By having the lender agree to a marshaling provision in your financing terms, you can ensure that business assets will be utilized first, rather than personal assets, in order to pay any outstanding indebtedness in the event that your business encounters future problems and a liquidation proceeding is necessary.
Marshaling will designate the order of liquidating pledged assets, leaving any personal assets intact as long as possible. Failing to resolve this issue during the loan application process will allow the lender the ability to elect which assets it will first proceed against in its sole discretion, if and when your business defaults on the loan.
When evaluating business loans it is also important to consider the covenants required by the lender and set forth within the loan commitment letter. These covenants, which may be both affirmative and negative, govern specifics of certain actions that you can and cannot do throughout the term of the loan. They may run the gamut from predetermined salary limitations for the company’s principals, to prohibitions on future acquisition of capital assets, as well as on additional borrowing from third party lenders.
Carelessly crafted loan terms can leave you without options in the event that your financial needs change and without an adequate provision to allow for expansion in the amount or type of credit facilities. Additionally, financial covenants, such as maintaining a minimum net worth or loan balance to fair market collateral value, which can apply to both equipment or real estate, may effectively provide the lender with a report card for your business. Such covenants establish financial expectations that must be met on an annual basis as a condition of the loan. Therefore, it is important to include your business accountant in such reviews and negotiations in order to provide reasonable assurance that the covenants can be complied with on a timely basis.
While it is true that an attractive interest rate may initially be very seductive for a business borrower, evaluating an extension of business credit based upon any single standard can tend to be dangerous because it provides the potential that the loan may not be advantageous to your business on an overall basis. By focusing on a lower interest rate, you may be overlooking other critical aspects of the loan, which may be far more harmful than an extra ¼ or ½ of a percentage point on the proffered interest rate.
One overriding factor to keep in mind is that in many instances, a number of the terms and conditions of a loan commitment may be negotiable. No business should enter into a loan commitment with a financial institution without the benefit of its professional advisors, who will work to protect its best interests.
by: Gary G. Breton
July 14, 2014