You had a dream. You dreamed of owning your own successful business. You tested your products and created a business plan. You pitched it to every friend, relative, and stranger on the corner, and everyone loved it. Now, you’ve reached the point where it’s finally time to decide whether this is going to be a side hustle or your main source of income moving forward. You’ve decided to go for it and the only task that remains is finding the small business loans you need in order to grow.
You thought loans for small business would be easy to come by, after all, small businesses are the lifeblood of local economies! Instead of finding a welcoming place to grow your company, your big, national brand bank turned out to be very skeptical of your chances for success. They offered you a small business loan, but only if you accepted something called a “loan covenant.”
Keep reading to learn more about how loan covenants protect the big banks by restricting your plans for growth. Then, contact The Commercial Finance Group in Atlanta to learn more about how asset-based lending can provide a more flexible alternative.
What Are Loan Covenants?
Chances are you’ve never heard the term loan covenant before, so let’s spend a minute discussing its definition. In the commercial finance world, “loan covenant” is a term used to describe a promise the bank requires borrowers to make in regards to paying back the loan. These agreements typically restrict the borrower’s future actions in some way, are designed to preserve the lender’s position of power, and increases the chances that the loan is paid back on time and in full.
Types Of Loan Covenants Common To Bank Financing
When seeking a loan for small business, you’ll likely be presented with one of the following covenants, provided you’re deemed “bankable” by the financial institution of your choice:
Affirmative Loan Covenant – This type of covenant is made to encourage the new business owner to make financial decisions that will preserve the health and well-being of their new venture (and thus, the bank’s investment). Affirmative loan covenants may ask a business owner to promise that they will:
- Pay all business and employment-related taxes
- Maintain current, honest financial records and reports
- Maintain insurance policies for the business
- Maintain the company’s legal status or entity
If one or more of these loan covenants is violated, it may give the bank cause to “call its loan, halt any additional lending to you, exercise its right to seize any assets you posted as collateral, or initiate legal action to recover its money,” explains Randy Myers for Entrepreneur.com. The same goes for any of the additional covenant types below.
Negative Loan Covenant – This type of covenant is made to create boundaries for new business owners and prevent them from doing certain things that the bank feels would put the health and well-being of the business at risk. Negative loan covenants may ask a business owner to promise that they will:
- Limit the total amount of indebtedness for the business and/or shareholders
- Restrict or forbid distributions and/or dividends paid to shareholders
- Restrict or forbid management fees paid to related parties
- Prevent mergers or acquisitions without express permission
- Prevent sale or divestiture without express permission
- Maintain a specific Debt Service Coverage Ratio
Financial Loan Covenant – This type of covenant is made to provide a means for measuring the businesses performance against projections. Banks use projections to decide how much they’ll lend a specific company, and it’s in their best interests to make sure the company is living up to those predictions. Financial loan covenants may judge a business based on certain measurements, including:
- Current Ratio (Current Assets divided by Current Liabilities)
- Borrowing Base Calculation (defined maximum percentage against the business’ eligible accounts receivable to determine limits on a line of credit)
Asset-Based Lending Is An Alternative To Restrictive Bank Loans
If you’re a new (or experienced!) entrepreneur who would rather not have to sign themselves away on quite so many dotted lines, please consider contacting The Commercial Finance Group in Atlanta. We specialize in customized lending solutions, including asset-based lending, which don’t include nearly as many restrictive covenants and terms. We allow you to leverage the assets your business already had to finance its growth. Contact us to learn how!
