Loan Agreements

Loans are a well-known method of raising money for a business. A major disadvantage to a loan is that the bank (or other lender) requires that the borrower pay back the loan whether or not your business is successful. One advantage to a typical loan is that if your business does well, the lender is only entitled to an interest return on its loan rather than a percentage of the business profits, or a share in the company, which is what an equity investor would expect.

A Loan Agreement covers many of the same points as a Promissory Note; however, it is a lengthier and more complicated document and covers a more complicated transaction.

Whether you obtain your loan from a bank, individual, or other lender, a number of variables in the loan document can affect how good or bad a loan is for your business. Virtually all the terms in a loan agreement are negotiable; there is no such thing as a "standard loan." The key issues to negotiate when contemplating getting a loan for your business include the following:

• Due date. You need to set a date when the loan's principal is to be repaid. This date can be formulated as a lump sum payment at the end of the term of the loan, or as a periodic payment of principal with a final payment. For example, you can agree to borrow $50,000 with the entire principal due in two years. Or, you can say that the principal is repaid in 20 equal monthly installments of $2,500. In any event, make sure that the payment schedule (interest and principal) is reasonable given your anticipated cash flow.

  
  

• Interest payments. The lender establishes the interest rate, which should be in compliance with the applicable state usury laws — laws that govern how much interest can be charged on a loan. The loan payment dates should be clearly set forth; the most common method requires monthly payments by the first day of each month. If your cash flow situation is such that a great deal of cash comes in after the first day of the month, then try to adjust the timing of the required loan payments. Also, you will want to know how much of any monthly payment covers interest and how much covers the principal.

  
  

• Loan fees. The lender may charge up-front loan or processing fees. Be careful on the amount, and try to get an estimate as soon as possible so you can evaluate how attractive the loan is as a package.

  
  

• Prepayment. Ideally, you want to be free to pay off the loan at any time, even earlier than its due date. Make sure that your loan agreement or Promissory Note gives you this flexibility. Try to avoid a prepayment penalty for paying off the loan early.

  
  

• Defaults. The lender is likely to insist that a variety of events can cause a default under the loan, including failure to make payment on time, bankruptcy, and breaches of any obligations in the loan documents. Try to negotiate advance written notice of any alleged default, with a reasonable amount of time to cure the default.

  
  

• Grace period. Try to get a grace period for any payments. For example, the monthly payments may come due on the first day of the month but aren't deemed late until the fifth day of the month.

  
  

• Late charge. If the loan includes a fee for late payment, try to make sure that the charge is reasonable.

  
  

• Collateral. The lender may insist on a pledge or mortgage of some asset as security to protect the loan. Under a mortgage (for real property) or a Security Agreement (for personal property), if you default on the loan, the lender is able to foreclose upon the asset and sell it to repay the money owed to the lender. If you are required to provide security, try to limit the amount you have to give to secure the loan. Make sure that when the loan is repaid, the lender is obligated to release its mortgage or security interest and make any governmental filings to acknowledge this release.

  
  

• Co-signers and guarantors. A lender may ask for a co-signer or guarantor as a way to further insure that the loan will be repaid. A co-signer or guarantor runs the risk that his or her personal assets will be liable for repayment of the loan.

  
  

• Attorneys' fees. The lender is likely to insist on a clause saying that should you fail to make payments, you will have to reimburse the lender's fees and costs in enforcing or collecting on the loan. Just try to insert a qualifier that the reimbursement only covers "reasonable" attorneys' fees.

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And, since you will want to understand your projected or current business cash flow in order to put together your loan application, you can also learn from our plain-English buyer's guide to cash flow management tools. It's one of the AllBusiness.com guides to important business issues. Check out now.