Checklist Description
This checklist provides an overview of loan agreements.
Definition
Most businesses need to borrow money, and obtaining a loan from a bank is the most usual way of financing a business. If successful in an application for a loan, an individual, partnership, or company has to enter into a loan agreement that sets out the terms on which the loan is given.
A loan agreement is entered into by the bank as lender, and by the individual, partnership, or company that borrows as borrower.
A loan agreement contains all the terms and conditions under which the lender will lend the borrower the money. It states the amount of the loan, when the amount will be lent, the tranches if the money is to be lent in amounts at different dates, the repayment schedule, the interest to be paid by the borrower, and other conditions, terms, and warranties required by the lender from the borrower.
The repayment schedule is usually very precise and will state the exact dates on which the lender expects to be paid back by the borrower. The loan agreement can contain a voluntary prepayment clause that will allow a borrower to prepay the loan in certain circumstances. It may also set out mandatory prepayment obligations that apply in certain cases—for example, if the borrower sells or lists its business, or if the business is acquired by someone else and control changes hands.
A loan agreement specifies the rate of interest, and how this will be calculated and paid by the borrower. It also deals with the consequences and penalties in the case of default on payments by the borrower.
The borrower usually has to pay the lender an arrangement fee for the loan and is also expected to pay all reasonable legal, accountancy, valuation, and due diligence costs and other fees, costs, and expenses of arranging the loan.
In general, a bank will not give a loan without obtaining security for that loan. The loan agreement will contain details of the debentures, guarantees, or charges given by the borrower as security for the loan.
The borrower will be asked to make and give certain representations and warranties in relation to its constitution and business. It will also be required to give certain covenants (promises) as to how it will conduct its business in the future.
Advantages
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A loan agreement sets out the terms and conditions upon which a bank will lend money to a borrower.
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Because it is an agreement, it can be negotiated and agreed by the two parties.
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A loan agreement protects both parties and is a legally enforceable agreement.
Disadvantages
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In practice, a bank sets its own conditions for lending, and a borrower will have to comply and agree to such terms if it needs the funds.
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Negotiating a loan agreement can be complex and time-consuming. The documentation must be thoroughly understood, and if specialist legal advice is required the process may be expensive.
Action Checklist
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Study a loan agreement carefully before you sign. Obtain as much information from as many sources as you can before committing to an expensive agreement.
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Shop around for a better deal. Go to several banks and see if there are better offers and conditions for the loan you want.
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Be prepared for long and complicated negotiations, which could prove time-consuming and costly.
Dos and Don’ts
Do
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Choose your bank carefully.
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Make sure that you understand the conditions of your loan.
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Involve your solicitors in the evaluation of both the risks and benefits of entering into a loan agreement.
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Check if it’s possible to negotiate the terms and conditions of the loan.
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If in trouble with repayments, tell your bank as they may be able to help in various ways, such as temporarily reducing your repayments.
Don’t
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Don’t make the mistake of being attracted by a loan without understanding the implications of all the terms of the loan and the total cost to your business.
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Don’t overlook the importance of negotiating warranties and indemnities that you will be able to give with confidence. If you know of anything that may go against these warranties, disclose it to the bank.
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Don’t ignore the importance of telling the bank if you have problems with repayments. It might prove to your advantage.
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