We all know that to confirm and make any business deal binding all the parties involved in that deal sign a contract. Similarly a loan is a deal a business makes with a lender and to make the loan binding there is a contract known as a ‘loan agreement’, think of this like the marriage certificate that binds a couple! Just how a husband vows to live happily with his wife, in a loan agreement both parties make promises to each other- the lender promises to give money and the borrower promises to repay it. Now in case of any problem this agreement will serve as proof to resolve it in court.
Why is a business loan agreement important?
Whether you need a loan to start your business, whether you need it to buy a building or equipment, whether it’s for working capital or even if it’s for expanding, a business loan agreement is important in all situations. You may be borrowing the loan from a bank, NBFC, online lender or even friends and family, whoever the lender is in all cases signing a business loan agreement is a must. It protects not only the parties involved but also the relationship between the parties. A loan agreement makes the loan valid and in an unfortunate situation if any party fails to comply with the agreement they can be taken to court.
The basic information that any business loan agreement include are:
- Amount & duration: A loan agreement includes the amount of the loan a.k.a. the principal amount, the duration for which the loan is granted and also the effective date on which the loan will be disbursed. This date is usually the date when you sign the loan agreement.
- Parties involved: The two parties to the loan agreement are usually described in the beginning. In case there is a co-signer i.e. anyone helping the business with down payment or collateral, then he/she is also described in this section.
- Definitions: Just like any contract a business loan agreement has a list of definitions explaining the key terms. In case there a dispute regarding the terms these definitions help solving the dispute. So make sure you read these carefully before signing.
- Interest clause: This clause states how much interest you need to pay on the loan and also the type of interest whether it’s fixed or floating. Along with this it also includes the penalty charges you’ll have to pay in case you default on an interest payment.
- Repayment clause: The prepayment clauses states how and when a loan is to be repaid. You could either repay it in a lump sum or on a periodic basis depending on what’s written in this clause. In case of periodic basis the loan agreement should further specify the number of instalments and the date when each instalment is due.
- Prepayment clause: In case you repay a loan before the due date you’ll be charged a penalty, that’s why this clause must outline all these details.
- Loan security: The loan could be a secured loan or an unsecured one, meaning it might be given against a collateral or can be collateral free. If it’s a secured loan in case of a default the lender can seize the collateral against which you borrowed the loan. This section of the agreement mentions whether it’s a secured or unsecured loan and if secured which asset should be kept as collateral.
- Covenants: A business loan agreement will contain a list of covenants and conditions that the borrower must comply with. These covenants might include mandatory hazard insurance, life insurance for the owner and lender listed as the beneficiary, updated taxes, fees and licenses, conditions such as no change in management or borrowing any more loans etc. In case you as a borrower fail to adhere to them then the lender can demand full repayment of the loan.
- Miscellaneous fees: In case there are any more charges other than interest payments they’re included in the agreement with explanations and amounts. Example: Some lenders charge a loan processing fees. That’s why as a borrower you must read the fine print and make sure the fees are reasonable.
Each element of a business loan agreement is important and one must understand them carefully. If you cannot understand something ask your lawyer for help. Take your time and read it carefully before signing, basically watch out for the fine print because ‘terms & conditions’ apply!