Small and medium businesses may focus on the major business terms when negotiating the terms of a new loan – i.e., interest rate, term, collateral, guarantors and usually financial covenants. While these terms are critical for an effective letter of intent that can be projected into a set of loan documents, most lenders have loan documents that include their standard terms and provisions that borrowers may wish to negotiate and address in advance when their negotiating position is strongest.
This article suggests several areas to consider and perhaps raise during the negotiation of a letter of intent for a loan, which is the best time to obtain concessions and more borrower-friendly terms.
Borrower should consider requesting prepayment rights without fees, premiums or penalties. Prepayment fees will be largely unavoidable for fixed rate loans (which are now rare unless achieved synthetically through a swap or similar financial instrument), but can sometimes be mitigated for variable rate loans. Lenders may also allow prepayment during the last few months prior to maturity or in certain specific circumstances (e.g., a change of control).
In the current financial climate, the primary means to obtain an effectively fixed interest rate is to use a financial instrument, usually an interest rate swap, to achieve the "synthetic" fixed rate. A synthetic fixed rate loan is actually two separate relationships: first, the typical lender/borrower relationship with a variable interest rate; and second, a contractual relationship between the borrower and swap provider. This arrangement is a separate and independent set of form documents that are used internationally. Please see our previous article regarding swap transactions
Particularly with smaller, closely held companies, lenders will generally require that the same group of owners maintain ownership, or at least control of the borrower, resulting in often vague and broad prohibitions against any transfer of ownership. The borrower and its owners should consider the borrower's equity-financing plans, as well as the owners' estate planning, and negotiate terms that will accommodate those plans. A covenant prohibiting any change in ownership can be scaled back or limited; for example, by allowing transfers so long as a certain group (the initial owners, members of a family, etc.) own a certain percentage of the borrower such as 51%. A borrower can also request that the lender allow transfer to affiliates and family members (including trusts) for estate-planning purposes.
As with the ownership of a borrower, lenders also generally want the borrower to maintain its management personnel. As with ownership issues, this too often translates into broad and/or vague covenants not to allow any change in management. A possible compromise is to specifically identify a small number of key individuals (e.g., CEO or Executive Director, CFO and COO – the relative importance may depend on the industry) whose replacement would require at least advance notification to the lender, triggering a default.
The lender may wish to secure its loan to the business with all assets of the business. The scope of the collateral will be affected by the type of business and the type of loan. Regardless of the type of business or loan, consider the following:
Is the lender over-collateralized, or is there a risk of over-collateralization? In other words, the market value of the offered collateral pool should not, if possible, vastly exceed the amount of the loan. This may not be possible to avoid (e.g., if the primary asset is real property securing a modest line of credit).
Is the business obtaining multiple credit facilities and offering different types of collateral? If possible, collateral should be matched to the type of loan. An amortized term loan used to purchase real estate should be secured by the real estate; an operating line of credit can be secured by personal property. Try to avoid cross-collateralizing the two loans. This is particularly important if the two loans have different terms. If you later find another lender that can offer better terms on a line of credit, it may be difficult to obtain that loan if your existing term loan is secured by all personal property as well as real property.
The theme running through these suggestions is to maintain the most flexibility for your business. If you would like assistance in negotiating a loan, do not hesitate to contact Simon Inman or John Mackie of CMPR.