Our expert team at FWJ regularly provides advice to lenders and borrowers on secured and unsecured lending.
Why offer or use a loan?
All businesses will, from time to time, need additional funding whether it is capital to start a business, to acquire new assets, to exploit an opportunity to expand and develop the business or cash flow assistance to deal with short-term expenditure needs or revenue shortfall. For a business owner, one way to obtain the necessary business funding would be to borrow the money.
You may be someone who wishes to help a personal contact by providing a loan from your own resources or whose business it is to provide funding to other businesses. You would choose to make a loan because you also wish to be repaid, as opposed to making a gift, where you do not expect anything in return.
Types of loan
There are, of course, a great many different types of loan available to businesses of increasing complexity as the amounts involved and the demands of business increase.
Although there is a lot of jargon and different names for types of loans, at its most simple the main distinctions between types of loans are whether the loan is:
- a “term loan” (generally for a fixed sum repayable over a certain period of time) which is better suited to meet capital needs or a “revolving loan” (where a fund, up to a maximum limit, is available to a business which can be repaid and re-borrowed over an open period of time) which can provide the flexibility to meet fluctuating demands on a business’s cashflow; and
- secured or unsecured loans (see below).
Types of lenders
From the least to the most sophisticated, there are very many types of lenders:
- family and friends;
- directors and shareholders: these and the above category of potential lenders are the least likely to have prior experience of providing business funding or using written loan agreements and therefore can be the most vulnerable to loss because they may not know or be unwilling to properly protect their interests in the loan repayment;
- banks and other financial institutions: these types of lenders will have their own, largely pre-prepared terms and conditions, which for small businesses can be hard to negotiate or change, but it is important that they are fully understood, particularly as they may be lengthy and use unfamiliar language;
- alternative finance providers;
- asset based lenders.
What is the difference between secured and unsecured lending?
The difference between secured and unsecured lending is whether the borrower has given “security” for the loan. This means that the lender either has the ability to use assets of the borrower to raise money to repay the loan (such as a charge over land or other property owned by the business) or another person has given a promise to the lender to repay the loan if the business is unable to (a guarantee).
Why choose unsecured lending?
There are several reasons why the parties may choose an unsecured loan
- the personal relationship between the borrower and lender may mean that the lender is sufficiently comfortable to make the loan without security;
- the amount and/ or duration of the loan are such that it is not worthwhile to incur the cost of documenting security rights;
- the business does not have any assets, or sufficient value in any assets (possibly after taking into account other creditor claims) to cover the amount of the loan or other creditors will not permit the business to give further security to another lender.
There is a greater risk to an unsecured lender that the loan may not be repaid; the borrower may be unwilling or unable to repay when the loan is due. Where a borrower refuses to pay, the lender may consider commencing a debt recovery action. Where a business fails and enters an insolvency process, as an unsecured creditor the lender must share with all the other creditors of the business in any funds that the insolvency officeholder is able to realise, but this rarely results in a payment of all the money owed. Consequently, an unsecured loan may be more expensive to the business (with higher interest and other costs) to compensate the lender for this greater risk and the size of the loan offered may be reduced in comparison to a secured loan.
The different types of security
The different types of security can be found on our web pages dealing with the getting and giving of security.
What do you need to consider generally in respect of a loan?
A loan can be made on an informal or formal basis, however once you are outside a social context, it is generally advisable to have the loan, the terms on which it is made and to be repaid properly documented. This gives both parties clarity and certainty whilst recognising that the priorities of each will be different.
1. As a lender
Having first determined whether the business meets the lender’s commercial criteria for making a loan, as a lender your main concern is to ensure that the loan is repaid either through the mechanism of the loan agreement or the enforcement of any security. This is best achieved by effective, pragmatic documentation that takes into account the specific trading circumstances of the borrower.
2. As a borrower
Generally, these days an incorporated business has unlimited powers in its constitution to borrow money and give security for any loan, but it may be necessary to check that there no limits on amount or need for shareholder approval for any loan. Particular care may need to be taken over the directors’ decision-making process if a director, shareholder or other connected person is making the loan, especially if the business is going through a difficult period financially.
For the borrower the main considerations and negotiation points are going to be
- affordability – the amount of the loan, the interest rate, the size and frequency of repayments;
- control – how much involvement does the lender have in the day to day running of the business, reporting obligations and financial performance measures; and
- acceleration – what events could give the lender the right to demand full repayment early, limit availability of a revolving facility or enforce any security?
FWJ has experienced solicitors used to advising both lenders and borrowers in connection with all types of business funding and lending. We can draft appropriate bespoke loan documents in effective, user-friendly language or guide you through the terms of standard commercial loan agreements and highlight the impact of their provisions on your business, as well as assist you with the negotiations of the documents to ensure you have a loan on terms that are right for you.