From the 'Lectric Law Library's Stacks
Upon approval for a small business bank loan, you will typically be asked to sign several documents, including a loan agreement, a promissory note and some kind of personal guarantee.
Though most people do not give more than a cursory glance at this documentation, it is important to understand the terms and conditions you are agreeing to when you sign these pages.
Below is a description of each document as well as a few relevant points of consideration:
A loan agreement is a document setting forth the details of the small business loan. It includes information about the terms of the loan as well as the representations, warranties, and covenants of the borrower.
"Representations and warranties" is legal terminology that serves as your promise to the bank that you have complied with certain conditions prior to receiving any financing, whereas "warranties" refers to promises you as the borrower are making regarding what you will do during the term of the loan. The bank will also require you to affirm, usually by affidavit, that you have due authorization- i.e. you are authorized to bind your business to the terms of the loan.
A promissory note details the terms of the loan repayment, including the principal and interest, the length of the loan, late fees, and whether there is a prepayment charge. It also describes the circumstances under which the bank would declare your loan in default, as well as what happen should a default occur.
A default on a loan either occurs when the borrower does not make the required payments or does not comply with the terms of a loan in some other way. In the event of a default the loan may become immediately due and payable, it may be turned over to a collection agency, and the borrower's credit rating can be negatively affected. You can go a long way towards protecting your credit rating and personal assets simply by being aware from the start what qualifications and conditions surround a default.
Be sure to look for the cure language in the default section which allows you a certain time period, usually one to two weeks, to make amends after the bank has notified you about the default.
If the financing your small business receives from the bank is secured by collateral then a security interest will be included in the documentation. This section details the interest a lender has in the particular property that is being used to secure the business loan against the possibility of a default.
You will be asked to sign a standardized form known as a UCC-1, which creates a lien against the property- meaning you may not dispose of the property without first paying off the debt.
Most banks will seek a security interest in your business' inventory, accounts receivable and other tangible assets. Be aware that it is common for banks to even have an interest in the equipment or inventory you will buy for your small business after you have already received financing. Where possible, try to restrict the bank's interest to your current assets so you will not compromise your business's ability to receive equipment or inventory financing in the future.
Since most small businesses have insufficient assets or operating history for the bank to risk a loan- especially at the beginning- banks will often require a personal guarantee from the principals of the business. Basically, a personal guarantee is your promise to the bank that if your small business defaults on the loan, you will pay back the financing you received with your personal holdings, such as the equity of your home.
Be aware that the bank may require a personal guarantee even if your small business is a separate legal entity, like a corporation or LLC.
In short, if you are considering a small business bank loan as a financing option for your small business, then you only stand to benefit from paying attention to the fine print on anything you are required to sign. Small businesses may also consider alternative small business loan products based credit card processing that are unsecured; requiring no collateral.This article is brought to you by The 'Lectric Law Library and LookOnBusiness.LookOnBusiness provides essential news, information and resources pertaining to financing, currency and small business related topics. More information on these topics can be obtained by visiting their website at LookOnBusiness.com or e-mailing firstname.lastname@example.org