A business loan agreement has many elements that outline the various terms and conditions associated with getting a loan — including the loan amount, the interest rate, the repayment schedule, penalties, covenants, and dates. Understanding each of these can help you outline the terms and conditions of your transaction and supply you with the knowledge to potentially negotiate or adjust the business financing agreement format as needed.
1. Loan amount
This element represents the total amount of financing taking place within the transaction, or rather, how much funding is being transferred from one party to another.
2. Interest rate
This is the cost of the loan and how much interest will be charged on the outstanding balance. It can be either a fixed vs variable rate and can vary based on market conditions, the benchmark rate index, and the lender’s preference.
3. Repayment schedule
The repayment schedule outlines how and when the borrower will make payments toward the loan balance. This can happen in a variety of ways, such as monthly installments of principal and interest payments, a balloon payment, or on-demand payment.
4. Collateral
This represents the security required to recoup losses to the lender in the event of default. While not all loans will require collateral, it is one of the common small business loan requirements. There are various types of collateral, which can vary based on loan type, your qualifications as a borrower, and the risk tolerance of the lender.
5. Default provisions
Default provisions represent the potential consequences to the borrower if they miss their payments or violate terms of the agreement. The agreement should specify what constitutes default, and what steps will be taken following the instance of delinquency or default.
6. Penalties and fees
There are certain scenarios in which the borrower may be subject to penalties or fees. This can include prepayment penalties, where if the borrower pays off the loan early, the lender may impose a penalty fee to recoup financial losses. It may also take the form of late payment fees, should you miss a payment.
7. Covenants
Covenants represent stipulations that the lender may have surrounding the conditions of the loan. It may include specifying how funds may be utilized, not taking on further debt obligation during the timeframe of the loan, or keeping up with insurance coverage, if applicable.
8. Governing law
This element is in reference to the applicable laws associated with the agreement and the state of jurisdiction where any disputes will be settled if necessary.
9. Signatures
Signatures from both parties are required for the agreement to be considered enforceable. They act as the acceptance of the terms and conditions of the agreement noted by all involved parties.
10. Dates
This refers to both the effective date and the maturity date. The effective date is essentially the day in which the contract took effect and became enforceable, while the maturity date has to do with the timeframe in which the loan is expected to be repaid in full.
How does a business loan agreement work?
A business loan agreement is drawn up when a financing transaction takes place from one party to another. Essentially, after a financing application has been submitted and approved, both parties are required to sign the agreement before the transaction is facilitated.
Either party can draft the agreement, or rather, it should be drafted by a legal professional or other experienced person. Both parties will be expected to review and sign the agreement, although terms can be negotiated or adjusted beforehand.
Once the agreement has been drafted, negotiated, and signed, it’s considered to be legally enforceable, and the terms outlined in the agreement will take effect accordingly.
Why is a business loan agreement important?
A business loan agreement is important to ensure the protection of both parties involved in a financing transaction. Essentially, it is used to detail the various terms and conditions that the borrower and lender will abide by and to specify the expectations or obligations of each party.
What to do when signing a business loan agreement
There are a few common mistakes that are typically associated with signing a loan agreement. That said, you can aim to avoid them by being mindful of the following:
Frequently Asked Questions (FAQs)
Yes — if both parties agree to the modifications and you sign an amendment stating the new terms and conditions.
It depends on your comfort level with reviewing the terms and conditions of the proposed agreement. While it’s unnecessary to have a lawyer review it, it’s certainly worthwhile to have a legal professional help you understand the terminology and expectations of the financing agreement. They also may be a good reference should you have any questions or need help negotiating.
Yes. If you draft a loan agreement yourself, it is technically legally enforceable. That said, it’s recommended that a seasoned professional draft the agreement to ensure that all necessary elements are properly addressed and that the outlined terms accurately reflect the terms of the loan.
Bottom line
It’s worthwhile to familiarize yourself with the common elements of a business financing agreement, should you ever enter into one. By recognizing the necessary terms and expectations, you can prepare accordingly and ensure you know exactly what you’re getting into.
