Applying for a loan is a common step for a new or growing company, but if you’ve never made a loan application before, the process might be a mystery.
So, what can you expect to unfold?
The process often begins with developing a relationship with a potential lender. Introductions are typically made, and the lender will be interested in hearing the story of you and your company – what your company makes, why it makes it, what the growth potential looks like and how the loan will help the company.
Providing the lender likes what it hears, the first document you are likely to receive is a term sheet . A term sheet is much like a letter of intent and is for discussion purposes. It is not a legally binding offer and is only based on what the investor knows about you and your company at that time, prior to conducting its due diligence.
If you agree to the terms and conditions specified in the term sheet, you then pay a loan processing fee, which is based on the amount of your loan, and the investor will then begin its process of due diligence. The loan terms specified in the term sheet are subject to change depending on the information and level of risk discovered.
It may be tempting to flip to the last page of the term sheet, sign the document, and expedite the process. But taking a step back in order to understand all the terms and conditions will make sure you are meeting your obligations and save everyone a potential headache down the line.
The amount of funding proposed should be the first part of the term sheet. Verify that this is the amount you were expecting before moving on to the terms.
The term sheet will likely include information about how the principal will be repaid, as well as the interest rate that will be applied.
Security arrangements may be included in the term sheet or the loan document itself. The security section specifies the assets that will secure the loan – in effect, the collateral to be used as repayment if you were to default. This could take the form of first position for tangible assets, intellectual property, and the like. If you are confident in the success of your business and your ability to pay back the loan, this shouldn’t be an issue.
There may be a loan management and processing fee which will be stated in the term sheet.
If you agree to the terms, due diligence will begin, and this process may take a few weeks. Providing the lender is satisfied with what they learn, a letter of offer will be the next document you receive. Having a lawyer review the letter of offer is a recommended step at this stage, with the legal fees paid by the client.
Before any money is disbursed, standard conditions must be satisfied and these are commonly known as disbursement requirements and conditions (sic) precedent. These could include a signed resolution from your board authorizing your company to take on the loan, a certificate of insurance, in-house financial statements and other conditions as specified.
The letter of offer (also known as the letter of commitment ) is legally binding and commits you to the loan being offered. After the letter of offer is signed, you are officially obtaining funding from the investor and must meet all requirements and obligations.
The format of the letter of offer is similar to the term sheet, however the terms may have changed after the due diligence. Once the loan is disbursed, there may be underlying conditions that must be respected and maintained throughout the term of the loan. Examples might include submitting quarterly financial statements, annual audited financial statements, or receiving the investor’s consent before declaring dividends. All terms and rates are final, unless it is specified that they may be subject to change. Once you sign the letter of offer document, you have successfully arranged funding for your company.
The key at each stage of the process is to take your time, carefully read the details, and fully understand everything before signing. There’s no harm in asking your lender for clarification if you have any questions.
And, as always, BDC is available to help.
Banknotes is an occasional column offering financial advice to startups.
