Loan Terms & Conditions -Structuring the Deal for Medium Businesses | Friday January 30th, 2004 | |
Are you prepared to negotiate the terms on your loan?
Once the bank has completed its loan-purpose analysis, examined your company's ability to repay and decides to grant a loan, bankers determine the proper credit vehicle. They begin devising terms, conditions and pricing. The interest rate is one of the last decisions a bank makes, but usually one of the first questions a business owner asks.
One of the most important elements for an entrepreneur to remember is to establish creditworthiness before negotiating loan terms. You can’t even begin to discuss a loan or terms of repayment if you haven’t established that you can repay. For the banker, no amount of interest will be enough, if the loan is not repaid.
Interest Rates
Many different factors determine the loan price, especially if it is a large dollar-amount loan. A small business owner should not simply accept whatever loan terms are proposed but should try to use various negotiating tools.
If the loan is less than $50,000, or, longer than a year in maturity, don't expect to have much negotiating power or to be able to attach any compensating loan features. The bank simply isn't going to make much on the loan because of the small loan size. They know it and they won't compromise. But if your small loan is part of a larger portfolio your company has at the bank you might receive an exception. Remember the relationship does have some value to the bank.
Knowing how the bank determines loan values and how it compensates for lower interest rates can be a valuable negotiating tool. Most loans call for interest on a monthly basis because the bank earns more that way.
Another negotiating tool is to offer to have the loan interest deducted automatically from the business checking account every month. Banks typically give consumers an interest rate reduction of up to one quarter of a percent (.25%) off their auto and home loans rates if the consumer agrees to automatic payments. Try it for your business loan.
Fees are also a quick way for the bank to get bottom-line earnings and another negotiating tool for the small-business owner. A one percent “up front” loan fee is worth more than one percent when the line is fully utilized (it is worth 1.13%). If the line is only 25% utilized, then that same 1.00% annual fee has a yield value of 4.50%! Therefore be sure you are paying fees only on the money you are using.
Typically the bank will use a worksheet to determine the minimum loan yield. The small-business owner has no control over the bank’s current cost of funds, but is the biggest factor the bank considers. Banks have different profit “spread” requirements, depending on what type of collateral is supporting the loan. The degree of risk is determined from the financial analysis and comments about the loan itself. Additionally, the longer the term on your loan, the higher your interest rate will be. It is in your best interest (no pun intended) to realize that different credit facilities are priced differently.
Collateral and Support
Collateral and guarantees required by banks on most loans and lines of credit are not considered by bankers to be a reduction of risk, but simply standard operating procedure.
When collateral is required on the loan the small- business owner should provide a description of the collateral. If it is equipment or a motor vehicle, include model number, make and purchase price or value. If the loan is to purchase this asset, then include a copy of the purchase agreement with the name, address and phone number of the supplier. If it is an asset that you already own, be prepared to document that it is unencumbered and that the borrower owns its title.
But don't get the items appraised or verified until the bank desires it. Bankers don't want an appraisal from just anyone. They have their own list of approved appraisers for different categories. Also don't equate “appraised value” with “loan value.” They are very different. Appraised value is what you think you could sell it for given time and a generous buyer. Loan value is what the bank expects to liquidate it for if your plan doesn't materialize. The bank always bases the loan amount and decision on the most conservative estimate of the value.
Remember that the bank is not an asset lender, it wants the cash flow to repay the debt. Banks will not make loans based on collateral. They just require it as part of the loan documentation.
Personal guarantees are also standard operating procedure for loans to small businesses. Typically, an entrepreneur will inevitably have to sign one, so it is pretty much useless to try avoiding it. Your time is better spent negotiating the conditions under which the guarantee might be exercised because the bank will attempt to have the entrepreneur sign a blanket guarantee which covers everything. Agreeing to sign a guarantee with an established limit and tied to specific collateral allows the entrepreneur to use other assets without getting permission from the bank.
Loan Agreements
Once your banker has assessed your company weaknesses and summarized them in the comments section, then certain terms and conditions will be suggested in the loan recommendation. The bank will most likely use a loan agreement to stipulate any restrictions that must be adhered to, such as certain ratios and financial indicators. Other conditions such as how often financial statements are required and whether or not they must be CPA prepared will also be specified in the loan agreement. Collateral and guarantees are also described in the loan agreement.
Many times, the loan agreement is a standard, preprinted form, which binds the business owner in many ways besides those outlined by the banker. Your signature on the form indicates that you have read, understand and agree to adhere to the conditions and have received a copy of the loan agreement. Make sure all of this is true. Violations of these terms and conditions may allow the bank to “call” the loan or credit line and demand payment in full immediately.
Insurance
Insurance in an amount sufficient to cover the loan will be required on whatever collateral is pledged. The bank will want to be named “loss payee.” This means that if the asset is damaged, the bank has first claim on the insurance proceeds to pay back the loan, before you receive any insurance money.
Some banks may even be particular about your insurance company. They want to ensure that should a claim be filed, your insurer is able to pay. Therefore, you should know the name, address and phone number of your insurance agent(s) and which company they represent. Be prepared to provide a certificate of insurance and/
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