Every business owner is looking for a good financing deal. However, the $64,000 question is “what really constitutes a good financing deal?” Depending upon whom you ask, you will undoubtedly receive different answers. For many, it is securing the lowest interest rate while for others, it may be the length of the credit facility or even the nature of any financial covenants.
As you can imagine, there are no hard and fast rules, but there are a number of key factors to consider when negotiating a financing deal. They include:
- Interest Rate. Obviously, the interest rate is extremely important. The cost of borrowing can have a significant impact on a company’s profitability and return to the owners. When evaluating the interest rate, be sure to consider any upfront financing costs (i.e., points) as well as unused commitment fees. For variable rate loans, it is important to understand the underlying index.
- Length/Term. What is the maturity date of the loan? Loans may be structured to amortize for a longer period than their terms. For instance, a loan with a 5 year term may have a 20 year amortization. At the end of five years, a balloon payment will be due and, if the borrower is unable to make the large balloon payment, the loan will need to be extended or renegotiated under new terms which may not necessarily be as favorable as the existing ones.
- Prepayment Penalty. Certain loans may include a prepayment penalty in the event that the borrower chooses to repay all or a portion of the loan prior to maturity or refinance it with another lender.
- Covenants. Financial covenants such as debt service coverage ratios, tangible net worth requirements, or capital expenditure limitations are not unusual in a commercial loan. It is critical to understand the covenants and how they may impact your business. Accepting the wrong covenants could potentially handcuff your company and limit its growth opportunities.
- Collateral. Almost all commercial credit facilities are collateralized by personal property of the borrower, such as accounts receivable, inventory, and property and equipment. The definition of items such as “Eligible Accounts” can be a trap for the uninitiated. Loan agreements may contain provisions to exclude certain assets from available borrowing formulas, resulting in insufficient loan proceeds.
- Guarantees. Understand the nature and scope of guarantees. If there are multiple guarantors, resolve at once whether the guarantors will be jointly or separately liable. Consider ways to reduce or limit the exposure, such as limiting the guarantee to a specific amount or reducing it upon achieving certain financial targets or ratios.
- Intangibles. Different banks and relationship managers may have different risk tolerances. Understand how your company fits into their customer profile. If your business hits a few bumps in the road, will they be willing to work with you?
Negotiating a good financing deal can be challenging for any business owner. The lender has the money and with that comes most of the leverage. However, involving your accountant and attorney early in the process can help level the playing field by identifying the right mix of the factors discussed above, and structuring a financing package that is appropriate for your business.
Mark G. Metzler can be reached at Email or 215.441.4600.
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