Getting a loan or seeking financing can be bad for your business—this is a common misconception among business owners, especially starting ones. Here’s a FUN FACT. The vast majority of the world’s most successful companies needed financing somewhere along their journey to embrace their growth opportunities. To make these financing efforts fruitful, you need to be prepared and truly understand the terminology and finer points about a business loan, which are all laid out on a business loan agreement contract.
A business loan contract or loan agreement contract is a complex yet indispensable document that specifically outlines specific aspects of the loan. A business loan contract is important for both the lender and the business owner who applied for the loan because it is a binding agreement that signs both parties in their respective legal accountabilities. Sans this contract, both the lender and the business owner will not be able to clearly set the implications of loan defaults. In addition, in the event of default, the aggrieved party will have a more difficult time settling matters in court should there be a need for arbitration later on.
When sifting through a loan contract, it is important to keep in mind that while loans share some common terms and conditions, there are certain factors that make the terms in one loan different and distinct from another loan. The form and the accountability clauses of home loans and business loans make these two a perfect case in point. For example, a business loan and a home loan are primarily different because of the form of the loan and the requirements levied on the borrowing party.
Difference in form
Mortgage, home equity, and home equity line of credit are the typical forms of home loans while bank term loans, equipment financing, business lines of credit, purchase order financing, and invoice financing are some of the most common forms of business loans. Knowing the differences among these forms will help you have a better understanding of loan terms and how these terms impact the loan agreement.
Difference in liability
There is also a stark difference between home loans and business loans when it comes to liability. The impact of borrowing money against the value of your personal property is more serious than if you took out a loan through your business entity. Note that if you take out a home loan and fail to make timely payments according to the contract terms, the lender typically has the right to seize your home. On the other hand, if you secure a business loan and default on your obligations t, the lender will not be able to seize your home. If this is your primary concern, you may consider registering your company as a Limited Liability Company (LLC), your personal assets will have further protection as the lender would not be able to seize them.
Elements of a Loan Contract
With these considerations at the top of your head, you are now more equipped to review a business loan contract. So what elements should you expect in a basic business loan contract?
- Details about the Lender and Borrower
First off, a business loan contract specifies which party is the lender and which party is the borrower. It also shows information about the principal amount to be loaned and the interest rate. To provide this information, a loan agreement details complete information about the lender and the business owner, as well as the principal loan amount and the interest rate.
- Payment Terms
Another key item is the payment terms and the schedule of payment. Payment dates, duration, and frequency are all part of this section.
- Payment Method
Third important part of a loan contract is the payment method. In most cases, lenders provide more payment method options to make it more convenient for business owners to make their payments. Some of the most widely-used payment options include cash, check, credit card, or through accredited online payment facilities.
- Default Provisions
Lastly, a loan contract should indicate the consequences the business owner has to face in case they default on their contractual obligations.
Loan terms to watch out for
To cap off our discussion on loan contracts, here are some of the specific terms in loan agreements which you cannot afford to miss.
Interest is a key term in loan agreements. By knowing the interest rate for your loan, you will have a clearer and more concrete idea on how much it will cost to repay the loan.
In general, interest rates are either fixed or floating. As the term suggests, a fixed interest rate is constant and unchanging while a floating interest rate tends to change depending on the interest rate margin added to the benchmark rate.
There is another type of interest that is only applicable when the business owner who secured a loan is in a payment default status. Usually, the default interest is added to the total amount due for a certain payment period when the borrower does not pay on time.
Committed or uncommitted
When you agree to a committed loan, you will only get the disbursed loan amount from the lender once you are able to fulfill the Condition Precedents (CP) on the loan agreement. CPs are included in the contract as key dependencies toward securing a loan commitment. CPs are more common in real estate loans, but will often enough apply to business loans as well (e.g. the bank might require the business owner to take out a life insurance policy with the bank as payee as a CP for a loan commitment. If the business owner signs the document, a good faith effort should be made to secure such a policy and must succeed in order to secure the loan commitment).
Fixed or on-demand repayment
In most cases, lenders draft loan agreements where the business owner who secured a loan will be obliged to pay on a fixed schedule. In special cases, specifically, when the borrower has a low or questionable credit standing, the lender may request an on-demand payment scheme.
Secured or unsecured
Secured loans are loans that are secured by the assets pledged by the business owner as collateral. Secured loans have less risk than unsecured loans, hence lenders may offer a lower interest rate if there is collateral involved. While interest rates are usually higher when the loan is unsecured. Most traditional loans, like the ones from the bank, are secured.
Bilateral or syndicated
Bilateral loans are loans made and entered into by the business owner with the lender. When a loan is syndicated, which means two or more lenders are involved in the loan.
Here at First Circle, we value our partners’ trust.
This article serves as a primer to help you review and understand the terms of a loan contract before agreeing to one. If you’re ready to apply for a loan, it’s good to consider Fintech companies that offer quick and more accessible business funding to cover short-term capital gaps.
At First Circle, we value our customers by providing transparency in our business loan contracts. Our loan agreement documents are completely transparent, devoid of hidden charges, and easy to understand. Let us show you how we can help finance possibilities for your business.