You are the founder of a growing UK start up company. You have been to sort out a new borrowing facility with the company’s targeted bankers. Rather than enter into an overdraft, you are offered more favourable terms, if you enter into a fixed period loan (otherwise known as a term loan).
How is the “credit crunch” impacting on borrowers in the UK?
What does the process involve?
Can I negotiate the loan’s terms or are they “standard”?
Are the directors obligated to give personal guarantees as well as the company’s assets being charged?
These questions, and more, are regularly addressed by City lawyers, Fox Williams LLP.
Set out below are our suggested top ten tips for borrowers embarking on the loan process:-
1. Shop Around
Just because you bank personally with a particular bank for a period of time, does not obligate you to take out their other financial products for your start up! It is a good idea to try and get indicative quotes from other banks and finance providers. If you receive a better quote, take it back to your bank and negotiate.
Also consider the use of other ways of raising finance such as invoice discounting, stock facilities, finance and operating leases etc.
Borrowers should be aware that the credit crunch has restricted the number of loan approvals, being granted by credit committees. As such you may have a greater chance of getting your loan approved at your existing clearing bank. Also, if you stick with one bank, borrowers would hope (although it is no necessarily the case) that the bank would repay such loyalty when they need support down the line.
Before entering into the negotiation process, a borrower should consider what consents are needed.
- Is there a shareholder agreement containing consent matters? Shareholder approval may be required for the taking out of loans and the granting of security.
- Has other security already been granted (e.g. to a landlord in the form of a rent deposit deed)? These may contain “negative consents”, prohibiting the borrower from granting further security without the prior consent of the other security holder.
- Do all the directors agree with the loan?
3. Term Sheet
Once you have decided on the bank, the type of facility and obtained any necessary consents, it makes sense for the main terms to be set out in a term sheet. This will set out key terms such as the amount of the loan, interest rate, repayment date, early repayment fees, financial covenants etc.
The borrower should make sure the terms accurately reflect the negotiations with the bank.
Once signed, don’t start spending the facility just yet. There are several hurdles still to overcome!
4. Legal Representation
Lawyers for the Borrower
Before the term sheet is signed, instruct lawyers to make sure that there is nothing unusual included. Once a provision is included in a signed term sheet, it will be harder to negotiate away when it comes to negotiations on the final binding documents.
Lawyers for the Lender
Most of the term sheet will not be legally binding (allowing the bank to withdraw their indicative funding offer). However, some terms, such as costs and confidentiality, will be in force from signature.
When the term sheet is signed, the borrower will often be committing to pay the bank’s legal costs. The borrower may be obliged to pay the bank’s costs even if the loan facility isn’t made available.
The borrower should make sure they have agreed a cap on such fees and discuss the position if the bank withdraws.
Although loan arrangements can be expedited, the process will often take longer than the borrower first thinks.
The bank will want to get comfortable with its ongoing due diligence. The borrower will also be faced with the onerous logistical task of satisfying a large set of conditions precedent requirements, not to mention negotiating the terms of the documents.
As stated above, often the crucial step is getting credit committee sign off!
6. Standard or bespoke
Particularly for a smaller loan, a bank may try to argue that the arrangements are documented on their standard terms. Not surprisingly, such documents will be bank friendly!
In the age of word processors, documents can be changed easily and few banks still use pre-printed documents.
You may be failing in your director duties if you sign up on standard terms without at least getting them reviewed and, if possible, negotiated. This is particularly true for larger term loans.
7. Focusing your Fire
When reviewing the documents, a borrower and their lawyer would be well advised to focus their fire. A bank will not be pleased if their security documents come back substantially re-drafted. Such documents are, by their very nature, designed to protect the bank. Amongst other provisions, they set out, in considerable detail, the rights of the bank if a loan isn’t repaid.
There are, however, some clauses where negotiation is expected, for example:-
i. Events of Default
These will set out the circumstances when a bank can demand immediate repayment of their loan e.g. if a borrower is insolvent, has breached the terms of the loan/security etc.
The borrower will have paid an arrangement fee for the comfort of a fixed term loan and harsh events of default would jeopardize such benefit.
Accordingly, the borrower should seek “grace periods” for certain defaults, which would typically allow them several days to rectify any alleged breach.
ii. Representations and Warranties
Again, these should be thoroughly reviewed and any necessary disclosures carved out. For example, if the borrower is engaged in any litigation, it should be expressly disclosed to the bank.
The bank’s gut reaction will be to try and get as much security as possible. If not happy with the unencumbered assets put forward by the borrower, they will often seek personal guarantees from directors and/or shareholders.
Directors should try and limit security to the assets of the borrower, as otherwise this negates the point of operating the business through a limited company in the first place. However, this is often easier said then done!
If personal guarantees are unavoidable:-
· negotiate hard on total caps on recovery;
· sign up on a several rather than joint and several basis; and
· consider performance criteria, whereby the guarantees will be withdrawn if the borrower hits certain targets.
9. Conditions Precedent
Often, the facility agreement will have pages of documents which will be required to be supplied to the bank before the loan is made available.
For example, board minutes, directors’ certificates, accounts, insurance and proof of third party approvals are often required. These “CPs” should be reviewed early in the process, to see if any will be problematical to obtain.
Rather than the company secretary producing board minutes in the company’s standard format, the borrower’s lawyers will negotiate a set with the lawyers acting for the bank.
10. Plan B
You should also have a back up plan both (a) during the initial negotiations with the bank and (b) after the facility is granted. Since the banks have tightened the purse strings and cut back on lending, there has been an increasing number of loans made by shareholders/directors to their companies.
We have experienced circumstances where banks have outlined approval to lend in Heads of Terms, progressed the loan negotiation and then failed to get credit committee at the last minute.
You should accordingly have a Plan B. Equally banks are increasingly alleging loan defaults, even when all interest and principal sums are paid up to date. If a borrower is in breach of a financial covenant or there is a technical default (such as a failure to lodge required financial information with the bank), you can be asked to put up more security or to repay part or all of the loan.
Once the facility has been drawn down, you now just need to start worrying about generating the funds to repay it!