When your business is a corporation and takes out a loan, it is incurring debt. Loans are a well-known and well-used method of raising capital. The biggest drawback to taking out a loan for your corporation is that a loan must be repaid, both principal and interest, if any. Further, if you personally guarantee the loan, the lender will expect you to repay the loan if the corporation is unable to pay. The positive aspect of a loan is that lenders typically are only entitled to repayment, not an ownership in your corporation or a percentage of the corporation’s profits.
Loans can be taken out from banks, other commercial lenders, or individual lenders such as shareholders, officers, directors, family, or friends.
Bank loans may not be available for small, pure startup corporations due to unattractive repayment terms including the requirement that the borrower personally guarantee the loan. Because of this, it may be desirable to seek a loan for your corporation either from an individual lender, such as those listed above, or from the U.S. Small Business Administration (SBA).
The current Small Business Administration was created by Congress in 1953 and provides information on starting, financing, and managing small businesses. The SBA loans no money directly; instead, it guarantees a percent of certain loans made by private lenders, up to a stated maximum. The SBA works with banks, lending institutions, and other investors. In order to qualify for an SBA loan, a borrower must demonstrate it cannot obtain conventional financing at reasonable terms. The owners of the borrower must also personally guarantee the SBA loan and show sufficient cash to repay the loan. An SBA loan guarantee can be very helpful in ultimately obtaining a bank loan for your corporation.
Lender Questions and Document Requirements
Commercial lenders and banks customarily require answers to a series of questions regarding any corporation to whom they are considering making a loan. Documents supporting the answers are also required.
Lenders will typically ask the following questions:
How much money do you want to borrow?
How will you use the loan proceeds?
How will you repay the loan?
Does your corporation have the ability to make the payments required under the loan?
Can you offer any collateral for the loan?
Are you willing to put up a personal guarantee for the loan?
Lenders will likely request the following documents:
A business plan;
Your corporation’s articles (or certificate) of incorporation, bylaws and other documents;
Your corporation’s tax returns for the last three years, or if your corporation has been in business only a short time, your tax returns for the same period of time;
Your profit and loss statements and balance sheets for the last three years, plus projected financial statements;
Your board of directors minutes or resolution approving the taking out of the loan;
A description of any litigation or bankruptcy proceeding involving your corporation; and
A completed loan application.
Most loan arrangements involve a loan agreement, promissory note and guarantee. Promissory notes are discussed below. Contrary to what you may be told, there is no such thing as a standard loan agreement. You have the ability to negotiate virtually all terms in any loan you take out for your corporation, and you should take advantage of this.
Some basic loan issues include:
Parties (including co-signors and guarantors)
Fees (including attorneys’ fees);
Payment terms (prepayment, grace period, late fees);
Use of loan proceeds;
Representations and warranties;
Events of default; and
Conditions to closing.
The SBA’s website at www.sba.gov is an excellent resource for information on starting and financing a new corporation. The site also offers links to state websites related to business issues.
A promissory note is a written promise to pay a specified amount within a specified period of time at a specified amount of interest and generally does not have to be notarized to be legally valid. You should sign only the original of a promissory note, which original will likely be held by the lender. Once the note has been repaid, you are entitled to (and should always) get back the original.
Promissory notes typically contain the following key points:
Date of the note;
Names of the parties;
Address to where payment will be sent;
Due dates for payment of principal and interest;
Whether the note can be prepaid;
Attorneys’ fees clause; and
Signature of borrower.
Usury laws may limit the amount of interest that can be charged on a loan by a non-exempt lender (banks and other regulated lenders are often exempt). Any interest charged on any loan you take out must comply with applicable state usury laws.
Promissory notes can be drafted to require payment in a number of different ways, including: equal monthly payments, equal monthly payments with a final balloon payment, interest-only payments and a final balloon payment, or single lump-sum payment of principal and interest. You should decide which of these choices work for you and your corporation, and then discuss your choices with potential lenders.
This information is from www.Forbes.com