Understanding Bank Loan Covenants
Saturday, April 23, 2011
There's more to a bank loan than the interest rate. If you're securing a loan for your business from a bank, be sure to consider carefully the covenants in the loan agreement. Put in place to safeguard the bank, loan covenants can stipulate everything from financial ratios that the borrowing company must maintain to salary caps for its executives. What's more, any violation of an agreed-upon covenant can signal to your banker that something might be awry at your company, and you run the risk of having the loan called in.
Understanding loan covenants before you sign on the dotted line can help you better comply or, perhaps, prepare to negotiate more realistic covenants.
The following five steps should help you navigate the loan-covenant jungle and put you in a better borrowing position:
1. Find out whether your prospective bank plans to retain your loan or sell it.
In the latter case, there's probably less room for maneuvering over covenant issues.
2. Inquire about the bank's expertise in – and funding experience with -- your industry.
covenants from industry specialists are often more realistic.
3. Ask to see a sample list of covenants before the date of the closing, so you can avoid a
situation in which desperation for funds -- or a lack of careful analysis – persuades
you to simply sign anything. Make certain that you can live with the bank's terms
about the consequences of going out of compliance.
4. Do a computer run of your company's past performance during the most recent one
-two-, and three-year periods to see if you could have complied with all loan
covenants, especially key ratios, if you loan had been in place before now.
5. If those results indicate future problems, schedule a visit with your banker and suggest
more realistic covenants.
Or……. Give One-For-The-Money a shot at handling your financing. There are no covenants to worry about. Your loan will be based on the appraised value of the real property and on “common sense” underwriting by using either the DTI (Debt to Income)
approach or the DSCR (Debt Service Coverage Ratio)
This article was published on Friday 08 June, 2007.
Small Business Seller Financing by test author
Small Business Seller Financing
Offering seller financing allows small business owners an opportunity to earn more substantial profits in the long run for the sale of his small business.
Consider how you can maximize your profits and minimize our taxes on the sale of your small business property worth $180,000. The balance on your underlying loan is $101,400 at 9.5% fixed, with 225 monthly payments remaining. The buyer has $20,000 cash to work with.
You agree to a sales price of $183,800 for your small business, accepting $19,000 cash down and $1,000 to cover closing expenses. You will carry back a wrap-around mortgage for $161,000 at 10.5% interest, amortized over 360 months all due in 12 years.
Your buyer agrees to give the realtor a small note for $3,800 as additional consideration toward the purchase price of your small business -- part of his commission. After paying the remaining $7,000 due the realtor and our $2,000 share of closing costs, you net $10,000 cash at close. Your unrealized net capital gain after closing on the sale of your small business is $69,600.
Structuring the deal this way the small business buyer is able to get in with a low down, lower costs and more attractive loan terms than he would achieve through traditional lending sources. So, we were able to sell a $180,000 property for $183,800 with the attractive terms.
After making the loan payment on the underlying first mortgage you realize a net monthly cash flow from the small business transaction of $505 per month on your remaining $59,600 equity. You will also receive a net payment of $85,033 from the balloon due in 144 months after paying off the underlying first loan.
Your do the math -- your $59,600 equity in the "wrap" mortgage has grown to $85,033! You received $10,000 cash at close and another $72,720 in net monthly payments over 144 months -- yet you still have an additional profit of $25,433 coming to you from the balloon payment!
The net result is that we achieved an effective rate of return on our equity investment of 11.8%, and most of it is tax deferred. That's the way you like it – you get yours now and Uncle Sam waits for his.
Not too shabby for a small business seller financing deal!
For small business owners, this is a great way to market your small business for a quicker sale. Many owners shy away from carrying back any paper on the sale of their business, and in doing so they not only increase the average time it takes to sell the business, but also deprives them of a healthy profit and an additional stream of income.
Posted by Commercial Lending at 21:35:16