Did you negotiate your last loan agreement - or just sign on the dotted line?

For businesses wanting to grow or invest, external finance can be an attractive option: access to the funds that they need, without equity dilution or participation.

But external finance has its downsides—namely terms, conditions, and covenants that can prove overly restrictive, potentially tipping the business into default in the event of unforeseen circumstances.

The result: financial penalties, an impacted credit score, the possibility of an expensive forced refinancing, or even the loss of control of the business. Even worse, if personal guarantees or securities are called in, directors can be personally liable. Horror stories abound of personal assets seized in the wake of an unforeseen breach of a financing agreement.

And right now, for instance, the business press is mining a rich seam of such stories that have emerged regarding the actions of Royal Bank of Scotland and HBOS in the wake of the 2008-2009 recession.

Check the small print

Unpalatable though such risks are, many directors and owner-managers see them as the price of gaining access to external finance.

As with getting a mortgage for their house, or taking out a personal loan to buy a car, they dutifully sign on the dotted line, and hope nothing goes wrong.

But here at The Legal Director, our view is that this approach is completely wrong. In loan agreements, everything is negotiable—and businesses should not agree to terms with which they are not comfortable.

In short: read the documentation carefully, understand the implications of what you’re being asked to sign, and feel free to take issue with terms, conditions, warranties, and covenants that seem excessively onerous or risky.

Basis for discussion

That said, it is impractical to imagine that entire clauses can simply be struck out—although, in our view, broad-brush so-called ‘sweeper’ warranties should always be excised.

The reality is that a lender will require financial covenants, and will place restrictions on actions that might potentially impair your ability to make repayments. And a lender will specify penalties in the event of those repayments not being made in a timely manner, and in full.

But the nature and duration of those covenants, and how they are calculated, is certainly negotiable. And while penalties may be exacted for non-performance, penalties that seem disproportionate should certainly be resisted.

Likewise with personal guarantees. Some form of personal guarantee may regrettably be unavoidable—but its terms, and its duration, are very much up for discussion.

In short, a loan agreement is exactly that: an agreement. And if you don’t agree with the terms and conditions that are being proposed, then say so.

Do your homework

As ever, business directors and owner-managers will want to approach such negotiations from a position of strength.

It’s best to undertake some fairly fundamental modelling of how particular risks might affect the business’s ability to make repayments, for instance. What might happen in an economic downturn? What would happen if a major customer—or supplier—went out of business? How much headroom is there in the finances—and is it sufficient?

It’s best, too, to enter into negotiations knowing that your internal systems are up to scratch, and that they will support your ability to make timely repayments, and signal well in advance any situation where that might come into question.

It’s sensible, too, to maintain a good relationship with your lender, and keep them appropriately informed—especially if trading conditions start to worsen.

Know the score

Above all, though, if in doubt, seek advice. Lawyers and corporate finance specialists are well used to dealing with such situations, and can provide timely and relevant guidance. Here at The Legal Director, for instance, our Client Legal Directors are very familiar with such situations.

Remember: it’s generally too late to change a loan agreement once it is in place: the time to make changes to a proposed agreement is at the beginning, before it is signed.

So when contemplating external finance, don’t leave the details to the last minute. Give your business plenty of time to reach the deal that is right for it—and if necessary, shop around.

Posted Thursday, November 2nd, 2017 by Warren Ryland



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