When you start a business, you generally have two ways to raise capital: loans and equity contributions. There are some obvious disadvantages to business loans. They require you, for example, to pay back the lender whether or not the business is successful, which is not the case with equity contributions. But the advantage of a typical loan is that if your business prospers, the lender is only entitled to an interest return on its loan — not a percentage of the profits or a share in the company that an investor would expect.
Whether you obtain business loans from a bank, individuals or other lenders, a number of variables can affect how good or how bad they are for your business. Virtually all of these variables are negotiable: There is no such thing as a standard loan.
Be sure to negotiate these key issues if you plan to get a business loan:
Due Date
In today’s global economy, business loan lenders don’t need to negotiate with you since they have the money and consequently the power, but you need to set a date when the business loan is to be repaid. This can be formulated as a lump-sum payment at the end of the term of the loan or as a periodic payment of principal with a final payment. Make sure that the payment schedule conforms to your anticipated cash flow and realize that interest will be charged to you either way.
Interest Payments
When a lender establishes an interest rate, it must comply with any applicable state usury laws. (These laws govern how much interest can be charged on a loan.) Often, however, usury laws will not apply to banks. The law may also allow a lender to charge a higher interest rate for business loans than for personal loans (such as consumer credit). The interest payment dates should be clearly defined — the most common method requires monthly interest payments due the first day of each month. You might also try to adjust the timing of your interest payments to match the cash flow patterns of your business.
Loan Fees
The lender may charge up-front loan or processing fees. Check these fees carefully, and try to get an estimate as soon as possible to help you evaluate the loan package.
Prepayment
Ideally, you want to be free to pay off the loan at any time before its due date. Make sure that your loan agreement or promissory note gives you this flexibility and try to avoid a prepayment penalty for paying off the loan early.
Defaults
The lender may define a variety of events that will constitute a default on the loan, including failure to make any payment on time, bankruptcy, insolvency and breaches of any obligations in the loan documents. Try to negotiate advance written notice of any alleged default, with a reasonable amount of time to cure the default.
Grace Period
Try to get a grace period for any payments. For example, the monthly payments may come due on the first day of each month, but they won’t be deemed late until the fifth day of the month.
Late Charge
If the business loan includes a fee for late payment, try to make sure that it is a reasonable charge.
Collateral
The lender may insist on collateral to secure the loan. If you are required to provide security, try to limit the amount you have to give to secure the loan. And make sure that when the loan is repaid, the lender is obligated to release its security interest and is required to make any government filings acknowledging this release.
Co-signers and Guarantors
A lender may ask for a co-signer or guarantor as a way to further ensure that the loan will be repaid. A co-signer or guarantor runs the risk that their personal assets will be liable to repay the loan. If you ask someone to co-sign the loan with you, you may want to draw up a co-signer agreement to let the person know how you will repay them if you default on the loan.
Attorneys’ Fees
The lender will likely insist on a clause that says in the event of any failure to pay on the loan, the borrower will reimburse the lender’s fees and costs in enforcing or collecting on the loan. Try to insert a qualifier that the reimbursement will cover only reasonable attorneys’ fees.
Impress your lender by pulling together all your documents. It will expedite the process. For specifics, read Documents to Gather Before Applying for a Business Loan.
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