By Nancy A. Park
Business owners are often so worried about money and obtaining enough of it to capitalize their businesses that by the time the loan documents arrive, they are ready to sign on the dotted line and be done with it. However, this is a crucial time to step back and make sure that what you are signing up for is what you bargained for. Otherwise, you might find yourself and your business hampered by so many bank consent requirements that you can’t operate your
business effectively. Or worse, you default on your loan without realizing it and there is no way to pay it when the bank calls it due early.
Loan documents are often a tall stack of long, boring and finely printed contracts with lots of boilerplate language. The dirty little secret of loan documents is that the “gotchas” are hidden in this so-called boilerplate. Have your summary of terms (or letter of interest) from the bank right next to you as you read the loan documents from beginning to end.
Then focus on the following five areas to prevent the mistakes borrowers most often make.
1. Check the facts: Is the borrower’s name and entity correct? At a minimum, check loan term (maturity), interest rate, names, payment amount, amortization, addresses and collateral description. Make sure references to interest rate, loan term, payments and other key loan terms match up with your summary of terms. Are the right properties or fixtures being included as collateral? Pay particular attention to “financial covenants,” such as maintaining a certain net worth or cash balances or ratios, and the timing of financial reporting. Be sure that the loan documents give your business time to cure problems if these requirements are not met during the loan term.
2. Review the possible defaults: There might be several places in the documents that list loan defaults, such as failure to pay by a certain time or failure to perform other loan terms. If any of the defaults seem like a real risk (now or during the loan term), then you should discuss this with your banker so you
are not backed into a corner from day one. Ask for a cure period for every default, and avoid having the loan declared due as the first remedy by the bank. Some common events leading to default are failure to pay, death of a key person in the business, or sale of the business or its major assets.
3. Representations and Warranties: Borrowers are usually asked to make numerous statements of facts or beliefs in the loan documents, called representations and warranties. Some of these can be very broad or include facts that the borrower may not actually know. It is important that you read carefully and feel comfortable that each statement is correct and within your knowledge. It is OK in many instances to limit these statements to the best of the borrower’s (your) knowledge.
4. Loan or Credit Agreements: One important loan document is a loan or credit agreement that contains the loan terms specific to your operations. Ensure the bank has not tied your hands with regard to your main line of business, such as prohibiting certain contracts or transactions. Often banks require their consent before allowing certain actions to occur. Be sure that key business activities are not restricted, or you have authority to act up to a certain limit before the consent of the bank is required. Ideally, the bank will have no say in key business decisions, but if it does, require the bank to act within certain time frame so it will not handicap your business activities.
5. Check for Other Terms: If something seems odd or overly restrictive, now is the time to get these things explained in plain language by your banker. Don’t be put off with phrases like “That’s just what the loan docs say, it never really happens that way.” Loan documents are enforced by the actual language that is included. It is extremely important that you understand everything and correct any inaccuracies. If the banker is not able to explain certain issues or change loan terms, then you will need to weigh the risk of this issue occurring against your need for the loan.
You may think that the loan docs are just a necessary evil that should be accepted the way they are to reach the end goal of cash. However, there is no substitute for actually reading all of your loan documents and understanding the actual terms. Even better, allow a lawyer knowledgeable with the customary compromises agreed to by banks and borrowers to give your loan documents a careful legal review before signing on the dotted line.
Nancy A. Park is of counsel at Best Best & Krieger LLP in the Sacramento office where she works with clients in both the private and public sector, focusing on real estate transactions, finance and business contracts. Ms. Park represents private and public real estate entities, lenders and borrowers, landlords and tenants, and large and small businesses. She can be reached at firstname.lastname@example.org or 916-551-2849.Read More
Seller financing has always been a mainstay of business brokerage. Buyers don’t have the capital necessary to pay cash, are unable to borrow the money, or are reluctant to use all of their capital. Buyers also feel that a business should pay for itself and are wary of a seller who wants all cash or who wants the carry-back note secured by additional collateral. What sellers seem to be saying, at least as perceived by the buyer, is that they don’t have a lot of confidence in the business or in the buyer or perhaps both. However, if you look at statistics, it’s apparent that sellers usually receive a much higher purchase price if they accept terms.
Studies reveal that, on average, a seller who sells for all cash receives only about 80 percent of the asking price. Sellers who are willing to accept terms receive, on average, 86 percent of the asking price. The seller who asks for all cash receives, on average, a purchase price of 36 percent of annual sales while the seller who will accept terms receives, on average, 42 percent of annual sales. These are compelling reasons for a seller to accept terms. Business brokers have long been aware that reasonable terms are necessary if sellers are serious about selling their businesses.
The primary reason sellers are reluctant to offer terms is their fear that the buyer will be unsuccessful. If he or she should stop making payments, the seller will be forced to take back the business, hope that the buyer can resell the business, or forfeit the balance of the note. Another reason is that sellers feel that they can do more with cash than with the receipt of monthly payments. How often do sellers say that they need cash so they can buy another business? That is probably not the real reason, but selling their business (or house) may be the only time that they can get a “chunk of cash.” A business broker can help alleviate these fears by pointing out some of the ways sellers can protect their investment and by explaining some of the advantages of carrying the balance of the purchase price. Equally important is how the deal itself is structured.
Let’s first take a look at the advantages to the seller of financing the sale:
- The chances of the business actually selling are much greater with seller financing.
- The seller will achieve a much higher price for the business with seller financing.
- Most sellers are unaware of how much the interest can increase their actual selling price. For example, a seller carry-back note at 8 percent carried over nine years will actually double the amount carried. $100,000 at 8 percent over a nine year period results in the seller receiving $200,000.
- With interest rates currently low [at this writing], sellers can get a much higher rate from a buyer than they can get from any financial institution.
- Sellers may also discover that, in many cases, the tax consequences of accepting terms are a lot more advantageous than those on an all-cash sale.
- Financing the sale tells the buyer that the seller has enough confidence that the business will, or can, pay for itself.
- The seller may be able to borrow some cash using the note and security agreement as collateral. It may not be as easy as borrowing against real estate notes, but it’s still better than nothing.
Many experts say no! These experts believe that only half of the business valuation should be based on the financials (the number-crunching), with the other half of the business valuation based on non-financial information (the subjective factors).
What subjective factors are they referring to? SWOT is an acronym for Strengths, Weaknesses, Opportunities and Threats – the primary factors that make up the subjective, or non-financial, analysis. Below you will find a more detailed look at the areas that help us evaluate a company’s SWOT.
Industry Status – A company’s value increases when its associated industry is expanding, and its value decreases in any of the following situations: its industry is constantly fighting technical obsolescence; its industry involves a commodity subject to ongoing price wars; its industry is severely impacted by foreign competition; or its industry is negatively impacted by governmental policies, controls, or pricing.
Geographic Location – A company is worth more if it is located in states or countries that have a favorable infrastructure, advantageous tax rates, or higher reimbursement rates. A company with access to an ample educated and competitive work force will also enjoy increased value.
Management – A company with low turnover in management and a solid second-tier management team comprised of different age levels is also worth more.
Facilities – A company operating profitably at 70 percent capacity is worth more than a company currently near capacity. Equipment should be up to date and any leases – either equipment or real estate – renewable at reasonable rates.
Products or Services – A company is worth more if its products or services are proprietary, are diversified with some pricing power, and have, preferably, a recognizable brand name. In addition, new products or services should be introduced on a regular basis.
Customers – A company is worth more if there is not heavy customer concentration, but rather recurring revenue from long-time, loyal customers, as well as from new customers created through a regular and systematic sales process.
Competition – A company not contending head to head with powerful competitors such as Microsoft or Wal-Mart will rate a higher value.
Suppliers – Finally, a company is worth more if it is not dependent on single sourced key items or items available from only a limited number of suppliers.
Copyright 2012 Business Brokerage Press, Inc.Read More