In order to start a business, many entrepreneurs apply for loans to help get their business up and running. There are a lot of moving parts to a business loan, but this article will help define and clarify the different elements and factors that come with a business loan and how to navigate through the legal documents before signing. Continue reading to learn more about the business loan process.
Business loan agreements govern relationships between borrowers and lenders by detailing key information like repayment terms and collateral. The loan agreement protects all parties on the contract by ensuring everyone understands their rights and responsibilities. For that reason, it’s important to understand the most common sections and terms of a loan agreement.
What Is a Business Loan Agreement?
A business loan agreement is a legally binding document that outlines the details of a loan between a lender and borrower. Loan agreements typically include information like the loan amount, repayment term and due dates, interest rates and other costs.
Not only do the best small business loans boast competitive rates and terms, but they also come with transparent loan agreements that business owners can understand.
How a Business Loan Agreement Works
Business loan agreements generally are provided by the lender—especially when working with banks, credit unions and other financial institutions. However, business owners who take out a private loan from an individual may need to provide their own agreement. In this case, there are a number of forms and agreement templates available online.
Keep in mind, however, that it’s best to consult with a business attorney when drafting a loan agreement. Likewise, it’s important to understand the most common sections of a loan agreement before it’s time to get a business loan.
Sections of a Business Loan Agreement
Most business loan agreements include the same general sections. The majority of variation occurs within these sections, where lenders can set their own terms and establish loan details as well as the mechanics of repayment, nonpayment and default. These are some of the most common parts of a business loan agreement:
The effective date of a business loan agreement is the date on which it becomes binding on all parties. With a loan agreement, this is usually the day the loan funds are disbursed.
Parties, Relationship and Loan Amount
Every loan agreement should include the names of the lender and borrowers at the beginning of the document, including each party’s address or other identifying information, as well as the relationship between the parties.
If there’s a co-signer on the loan, also include identifying information and describe their relationship under the contract. Finally, state the loan amount in this first part of the agreement.
Promissory Note or Mortgage
A promissory note is a portion of a loan agreement stating that the borrower agrees to repay a set loan amount at a set interest rate. As the name suggests, a promissory note is simply a promise to pay.
For a secured loan, the loan agreement should include a section that describes the collateral—generally referred to as the security agreement. In the case of a mortgage, the underlying collateral is the land and/or building being purchased. However, collateral may also be the financed vehicles or equipment, or other company assets.
Terms and Conditions
This section of a business loan agreement generally includes the details of an installment loan, including the installment agreement, as well as basic information like the loan amount, term and interest rate. This section also may state whether prepayment is permitted under the terms of the agreement.
Penalties for Nonpayment
The nonpayment section of a loan agreement describes what happens if the borrower misses a payment. Typically, this section indicates whether there is a grace period during which the borrower can make a late payment without being penalized.
Defaults and Acceleration Clause
This section describes what happens if the borrower defaults on the loan, including fines and other penalties. Likewise, the contract may include an acceleration clause that states that the entire loan balance becomes immediately payable if the borrower fails to meet all requirements set forth in the agreement.
Jurisdiction and Governing Law
Because law varies from state to state, every business loan agreement should include a section that specifies which state law is controlling. This is especially important in the case of a contract dispute, but it also dictates how the overall contract is drafted. For that reason, it is best to hire a local attorney who can ensure the loan agreement complies with applicable state law.
Representations of the Borrower
As part of a loan agreement, the borrower is expected to make a number of representations. This may include asserting that the borrower can legally do business in the state, that all financial representations made are true and correct, and that the business is in compliance with tax law.
A covenant is a promise made between the parties to a loan agreement. In general, the lender covenants to disburse funds in a certain amount and at a specified rate of interest, while the borrower promises to repay the loan according to the terms of the agreement. However, there are several more specific covenants found in business loan contracts, including a promise to:
- Provide proof of insurance for pledged collateral
- Acquire key person insurance on the life of the business owner
- Show evidence of payment for taxes and fees, including property taxes and vehicles licenses
- Pay lender expenses in the case of loan default
- Periodically produce financial statements during the loan term
- Refrain from taking on additional business debt during the loan term
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Original article published on forbes.com