by Yesenia Cardona, Charles Saydek and William Ryan
If you ever read (and I mean read, not just signed) a bank loan or revolving credit agreement, then you know the document can be a little overwhelming.
Whenever first 20 pages of a document include mostly definitions, you know it is going to be a tough read. Not only must you keep referring to what the words mean throughout the document, but every other word sends you to a different section for further clarification.
Of course, you should understand key words and phrases. You should challenge them if necessary. Treat this like any other business transaction—you want the best possible result with the least possible pain.
So let’s go through some important items we think you should understand and what questions you need to ask when dealing with your banking institution.
Collateral is the asset(s) you are pledging as security against repayment of the loan. You forfeit these pledged assets in the event of a loan default. Depending on the size of the loan or revolving credit, you want to make sure that the collateral matches or exceeds your loan or line of credit.
If the lender determines your line of credit based upon 80% of allowable trade receivables, then your only collateral may be your trade receivables. If the collateral includes all the company’s assets, then you may want to renegotiate the terms and see if you can reduce your exposure in case you default on your loan.
Read this section carefully.
When I provide a service, the quicker I get paid, the better. However, in many loan agreements, if you pay off your loan before the due date, the bank can hit you with a termination or prepayment fee. This is because the banks wants to keep you from switching to a competitor when interest rates drop—or if you find better terms.
Remove the early termination fees (if possible) from the agreement. If you cannot remove them entirely, then at least reduce the amount of time in which they apply.
The guarantor is the individual or entity that guarantees payment or performance of the whole or any part of the obligation (there may be multiple guarantors). Banks typically require this. However, depending upon the financial strength of your company, you may be able to negotiate this out of the agreement.
You might think to yourself: “I have a loan that is limited to 80% of my allowable receivables, but I gave as collateral all the assets of the company and I must guarantee the loan as well. This doesn’t seem exactly fair.”
These are examples of why you must better understand what your loan agreement does for you and what it requires from you.
The annual interest is typically a variable rate based on either LIBOR (London Interbank Offered Rate) or the prime rate. We’ve seen historically low-interest rates for the past eight years; however, they have slowly been increasing. Ten years ago, the prime rate was close to 8%. Choosing a higher fixed rate or a lower variable rate that can change is something to go over with your accountant.
An affirmative covenant is any promise the company must fulfill. Some example of affirmative covenants are:
A negative covenant prevents the company from certain activities such as
The lending institution may stipulate certain ratios which the company must reach that fall in the affirmative or negative covenant section. (Your accountant and lawyer should review each covenant to make sure you can comply with and/or meet them.) You may be able to negotiate your loan to remove or amend some of these covenants so that you are not in default at the onset.
You could default on your loan. The bank could issue a waiver, charge you with a fee or ask you to pay off the loan. “Charging a fee” seems to be a reoccurring theme in bank loans.”
When you are in need of bank financing, always check with your accountant and lawyer before entering into such an agreement. They may offer advice to alleviate burdens that lending institutions may try to include in the agreement—saving you time and money in the long run.
Yesenia Cardona, CPA, is a Senior Manager in the Private Business Services (PBS) Group at EisnerAmper LLP. She has 10 years of experience serving privately held companies across various industries. She provides services including reviewed and compiled financial statements, outsourced finance and accounting, and tax planning and preparation of tax returns for businesses and individuals. Cardona also has experience assisting U.S. subsidiaries of foreign entities with their financial accounting needs and tax services and reporting under International Financial Reporting Standards (IFRS).
Charles Saydek is a Senior Manager in EisnerAmper’s PBS Group. He has 15 years of experience in public accounting, serving clients in a variety of industries and specializing in business consulting, reviews, compilations, tax services and retirement plan audits.
William Ryan is a Senior Manager in EisnerAmper’s PBS Group. He has 15 years of public accounting experience, working with clients in a variety of industries. He specializes in audits, reviews, compilations, tax services, and business consulting.