A business loan agreement is a legal contract that defines the conditions of repayment, interest rates, required collateral, default penalties, and other terms between the borrower (a firm) and lender (usually a bank). Before you ask for a loan from a financing institution, it’s critical to evaluate your company’s demands.
A business loan agreement protects both parties in case of unforeseen events. Usually, a business loan agreement has a term period ranging from 6 months to 5 years. The borrower promises to pay the principal amount along with the interest amount in installments over time.
It is a legally binding document between the lender and borrower containing details regarding the loan, like loan amount, repayment term and due dates, interest rates, and other costs.
Working on the business loan agreement
Business loan agreements are generally provided by lenders when you are obtaining a loan from banks, credit unions, and other financial institutions. But when you obtain a private loan from an individual, you need to prepare your business loan agreement.
It is advisable to consult a business attorney while signing or drafting a business loan agreement. However, you must know a few common terms and sections related to it before drafting a loan agreement.
Components of a business loan agreement
The same general components are included in most of the agreements. However, some changes are made by the drafter regarding components like repayment, non-payment, default, etc. Some of the common components are mentioned below –
Promissory Note
It is a part of a loan agreement in which the borrower makes a promise to the lender to repay the loan amount with interest at the set date. In simpler words, it is a promise made by the borrower to the lender to repay his loan on time.
Effective Date
The effective date of the loan agreement is the date when the agreement becomes binding on both parties. Generally, it is the date on which the funds for the loan are distributed.
Parties, their relationship, and the amount of loan provided
The loan agreement must contain the names of both the lender and the borrower at the beginning of the document. It should also contain the address and other necessary identification details (like aadhar card no., PAN Card details, etc.)regarding both parties.
The agreement must also specify the relationship between the parties. You must mention if you are friends, relatives, or have a purely professional relationship with each other.
Lastly, it must specify the exact amount of loan borrowed by the borrower. It should be stated in the first part of the agreement.
Collateral
Collateral refers to the valuable property the borrower owns that will pass to the business or person lending the money if the debt is not repaid.
For the loan to be secured, the agreement must contain a section mentioning the collateral. In the case of a mortgage, the land purchased will serve as collateral. However, collateral can be a vehicle or any other asset.
Terms and Conditions Applied
The terms of an installment loan, including the installment agreement, are typically included in this section of a business loan agreement together with other essential elements like the loan amount, duration, and interest rate. Other terms and conditions, like whether prepayment is permitted by the conditions of the agreement, may also be stated in this section.
Penalties on non-payment
This section of the loan agreement includes conditions regarding what will happen if the borrower misses a payment. This section often states whether the borrower has a grace period in which to make a late payment without incurring penalties.
Clause Regarding Defaults and Acceleration
This section addresses the fines and other penalties that apply if the borrower defaults on the loan. The agreement may also contain an acceleration clause that states that if the borrower fails to comply with any of the conditions outlined in it, the full loan debt will become due immediately.
Jurisdiction Law
Every company loan agreement should have a provision that explains which state law will apply because laws differ from one state to another. This governs how the entire contract is written, but it is extremely vital in the event of a contract dispute. To ensure that the loan arrangement complies with appropriate state law, it is best to hire a local attorney.
Representations of the borrower
The borrower is required to make several representations as part of a loan arrangement. This could involve claiming that the borrower has the legal right to operate in the state, that all financial claims made are accurate, and that the company complies with tax regulations.
Covenant
A promise made between the parties to a loan arrangement is known as a covenant. In general, the borrower agrees to return the loan by the conditions of the agreement, while the lender commits to making payments in a given amount and at a certain rate of interest. However, company loan agreements may contain additional, more specific covenants, such as a guarantee to:
- Show evidence of insurance for the pledged assets.
- Get insurance on the business owner’s life.
- Show proof that all taxes and fees, including property taxes and car licenses, have been paid.
- In the event of a loan default, pay the lender’s expenses.
- Throughout the loan term, periodically prepare financial statements.
- Avoid accumulating new business debt during the loan period.
Business Loan Agreement Terms
The agreement generally contains jargon, and we are not able to understand what the agreement states. Here are some common terms used in a business loan agreement –
- Amortization – Loan amortization describes the method used to divide a fixed-rate loan into equal installments during the repayment term. Each payment typically includes both interest and a contribution to the principal amount.
- Annual Percentage Rate (APR) – The annual percentage rate (APR) for a loan is the annualized cost of borrowing, which includes the interest rate and any other fees or penalties.
- Co-signer – By agreeing to repay the debt should the principal borrower default; a co-signer might increase a prospective borrower’s chances of loan clearance. Where applicable, the loan contract for a company loan specifies the co-signer and their obligations under the arrangement.
- Curtailment – When a borrower makes a payment on their loan that exceeds the monthly amount stipulated in the loan agreement, the term “curtailment” is used. A partial curtailment takes place when the borrower makes additional payments but does not completely pay off the debt; a full curtailment entails doing just that.
- Balloon Payment – Term loan payments often comprise a portion of accrued interest and a portion of the principal amount. The principal is fully repaid in this scenario during the loan term. But some loans are designed so that all or a portion of the principal is still owed at the end of the term and needs to be paid back in one lump sum through a balloon payment.
- Blanket lien – All of the company’s assets are covered by a blanket lien. This kind of lien enables the lender to seize any of the borrower’s assets to recover the outstanding loan debt in the event of borrower default.
- Deferred payment loan – In a deferred payment loan, the lender and borrower agree that payments will start on a decided future date, as opposed to the initial due date that applies to conventional term loans.
- Factor rate – Invoice factoring and merchant cash advances are two examples of business financing methods that use a factor rate rather than a standard interest rate. Unlike traditional interest rates, factor rates are expressed as a decimal, which indicates the percentage of the total loan amount that will be repaid.
Conclusion
You must have now become familiar with the jargon related to business loan agreements. It is highly advisable to consult a lawyer before entering into a contract. But, it is essential to have some knowledge about it.
All the relevant information, like the effective date and provisions regarding non-payment, must be mentioned clearly in the agreement. You should analyze your company’s needs and obtain a loan for your needs. You must read the agreement carefully and understand its sections with the help of your attorney before entering into a contract because it is a legally binding document.
On Biznesshub, features articles on and about business, startups, and entrepreneurs. Biznesshub covers all kinds of business & startup related articles, including entrepreneur, etc.
