Q: Our bank requires a loan agreement as a condition for a long-term loan to our sports memorabilia store. What gives?
A: Welcome to the big leagues. With term loans, banks impose conditions--called covenants--on your future operations. The agreement states your rights (few) and your obligations (many). It's the real game and wipes out all verbal understandings. The agreement may not fit all business. Three key points to remember:
1) Terms are negotiable only before you sign.
2) Never accept unreasonable conditions.
3) Never sign anything you don't completely understand.
Get a draft of the agreement. Take it home. Read it carefully. Ask your attorney and CPA to coach you. Don't agree to prepayment penalties--except for SBA 504 loans. Don't agree to maintain compensating account balances. Never sign an agreement with a deemed insecure clause. This clause lets the bank call for payment at any time.
Don't agree to a balloon note that mismatches your repayment ability with the bank's repayment schedule. Balk at any requirements differing from prior discussions. As collateral, pledge specific assets--not all current and future assets to be named. Pay particular attention to the personal guaranty form and the rules under which the bank can call on your guaranty.
The cross-default and cross-collateral clauses roll all your present and future loans with this bank into one loan. Default on one and you default on all. In the future, you may want to seed your loans among several banks.
Negative covenants list what you can't do without the bank's waiver--for example, sell the business, buy assets, sign large leases, borrow more money, change management, or pay dividends or management bonuses. Positive covenants tell what you must do--like maintain specific financial ratios, submit timely and accurate financial reports, carry life and casualty insurance and more.
Can you play the game? Match the covenants against your operations for the past two years. Did you do anything that is now banned? Can your team produce the required reports? Could you have met the required financial ratios? Based on your financial projections, can you meet them in the future? If not, call time out to renegotiate.
George M. Dawson (firstname.lastname@example.org) is a small-business consultant and author of Borrowing to Build Your Business: Getting Your Banker to Say "Yes." (Upstart Publishing, $16.95, 800-235-8866). Send him your financing questions at email@example.com