(Note: This post was initially published on LinkedIn, and the following iteration is a syndicated version of the same.)
A business loan, a common type of financing agreement, is a legally binding agreement between a lender and borrower.
On its face, a business loan includes information including the purpose, amount, collateral, repayment terms, interest rate, due date, and default.
Diverse Forms of Financing Agreements
Financing agreements take many forms, ranging from simple promissory notes between friends and family, to more complex commercial contracts like mortgages.
While a promissory note might be little more than a private document spelling out how long a borrower must pay back money and what interest is due on the principal, a mortgage is a public filing that states the lender’s right to repossess through law enforcement and the courts.
Whether simple or complex, finance agreements are governed by local, state, and federal laws regarding such items as interest and repossession.
Providers & Negotiation of Financing Agreements
Financing agreements are usually provided by the lender, especially when the borrower works with banks, credit unions, or other financial institutions.
Business owners who take out private loans from other sources may need to provide their own agreement. Whether working with a bank or private source, the agreement should still be negotiated such that the final executed contract reflects the parties’ complete understandings and doesn’t reflect coercion, undue influence, misrepresentations, nondisclosures, mistakes, impossibilities or is otherwise unconscionable.
A financing agreement protects the parties by ensuring everyone understands their rights and responsibilities and is bound by them. For that reason, it’s important to understand the most common sections and terms of financing agreements, such as loans.
Key Provisions in Financing Agreements
Financing agreements generally contain provisions regarding:
#1. Parties
A loan includes the names of the lender and borrower, including each party’s address and other identifying information. Co-signors should also be identified.
#2. Amount
The amount of the loan should be set forth in the agreement.
#3. Effective Date
The effective date of the loan is the date on which it becomes binding on the parties, typically the date the funds are disbursed.
#4. Promise
The “promise” is that provision in the agreement where the borrower states that she agrees to repay the agreed upon loan amount at a set interest rate.
#5. Collateral
For a secured loan, the agreement should describe the security. In the case of a mortgage, for example, the collateral is the building being purchased.
Collateral may also be financed vehicles or equipment, or other company assets.
#6. Terms and Conditions
This section of the agreement generally includes the details of the loan, such as installments and interest rate.
#7. Nonpayment
This section describes what happens if the borrower misses a payment and may be in default. Here, the parties may agree to a grace period in which the borrower can cure the default with or without penalty.
#8. Default
If the borrower defaults, and fails to cure, she may become liable on the loan including fines and penalties. The loan may also include an acceleration clause in which the entire loan balance becomes immediately payable.
#9. Jurisdiction and Venue
Every loan should contain a section specifying which state law controls the agreement, and where disputes will be adjudicated.
#10. Borrower’s Representations
As part of a financing agreement, the borrower is usually expected to make several representations, including that she can legally do business in the state, that all financial representations she made are true and correct, and that her business is in compliance with tax law.
The borrower may also be required to show proof of insurance for pledged collateral, provide financial statements before and during the loan’s term, refrain from taking on additional debt, and pay the lender’s fees in the event of her default.
Guidance for Small Business Owners
These are just some of the provisions with which a small business owner should be familiar before entering into a financing agreement.
But even the simplest agreement may contain one or more terms unfamiliar to small (and sometimes even big) business owners like amortization, annual percentage rate, balloon payment, covenants, factoring, guaranty, interest only payment, letter of credit, lien, loan to value, underwriting, and warranties.
Failing to understand just one of these may lead to a world of hurt.
The best practice for small business owners is to work with experienced commercial contract professionals who can assist them to create, negotiate, and manage the types of financing agreements small business use every day.
