NFIB

Understand the Details of Your Loan Documents
10/ 01/ 2002

Provided by Kiplinger

Anytime you borrow money you'll have to sign documents delineating the terms of the loan -- how much is being borrowed; what collateral you'll be using; what the lender's interest is; and your promise to repay the debt, including guarantees.

The Loan Agreement
The loan agreement sets forth all the terms and conditions of the transaction between you and the lender. The key provisions include the amount, term, repayment schedules and procedures, special fees, insurance requirements, special conditions to closing, restrictive covenants, the company's representations and warranties (with respect to status, capacity, ability to repay, title to properties, litigation, and so on), events of default, and remedies of the lender in the event of default. Your attorney and accountant should carefully review the provisions of the loan agreement and the implications of the covenants. They should also analyze the long-term legal and financial impact of the restrictive covenants. You should negotiate to establish a timetable under which certain covenants will be removed or modified as your ability to repay is clearly demonstrated.

The Security Agreement
The security agreement identifies the collateral you'll pledge in order to secure the loan, usually referencing terms of the loan agreement as well as the promissory note (especially with respect to restrictions on the use of the collateral and procedures upon default). The remedies available to the lender in the event of default range from selling the collateral at a public auction to taking possession of the collateral. The proceeds of any alternative chosen by the lender will be used principally to repay the outstanding balance of the loan. There's a sample security agreement in the Appendix.

The Financing Statement
The financing statement records the lender's interests in the collateral and is filed with the state and local corporate and land-records authorities. It's designed to give notice to your company's other potential creditors that a security interest that will take precedence over any subsequent claim has been granted in the collateral specified in the financing statement. Specific rules regarding this document and the priority of competing creditors can be found in your state's version of the Uniform Commercial Code (U.C.C.).

The Promissory Note
The promissory note serves as evidence of your obligation to the lender. Many of its terms are included in the more comprehensive loan agreement (such as the interest rate, the length of the term, the repayment schedule, your ability to prepay without penalty, the conditions under which the lender may declare default, and the rights and remedies available to the lender upon default).

The Guaranty
The guaranty, which you personally execute, serves as further security to mitigate the risk of the transaction to the lender. You and your legal counsel should carefully review and negotiate the conditions of the guaranty, especially with respect to its term, scope, rights of the lender in the event of default, and type of guaranty provided. For example, under certain circumstances, the lender can be forced to exhaust all possible remedies before proceeding against you, or may be limited to proceeding against certain of your assets. Similarly, the extent of the guaranty could be negotiated so that it is reduced annually as the company grows stronger and your company's ability to meet its repayment schedule becomes more evident.

Although bankers understand and acknowledge an entrepreneur's resistance to providing a personal guaranty, they will often seek this protection from the company's principals to further mitigate their risk. This is especially true if your business is highly leveraged, has operated for fewer than three years, or pays bonuses that absorb most of its profits. Why do lenders usually insist on these protections? The lender's primary goal is to influence management to treat the funds borrowed from the bank prudently. In essence, the guaranty is a psychological tool, designed to keep pressure on the principals of the company to ensure prompt and regular repayment.

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Andrew J. Sherman, a nationally recognized corporate and transactional attorney, has spent over two decades as a legal and strategic adviser to hundreds of entrepreneurs and growing companies. He is a senior partner of the Katten Muchin Zavis law firm in Washington, D.C. and chairs its local corporate and technology department. Sherman is also an adjunct professor at the University of Maryland and Georgetown University, where he teaches entrepreneurship and business planning.

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