For many entrepreneurs, borrowing money through loans is one of the few options available to raise capital when starting or growing a business. While borrowing can be a smart move, it also comes with risks that can put your business at risk. You need to understand that risk, and we have put together a guide for you so you can make the smartest decisions for your business.
Balance the Risk with Business Loans
You need to ensure you’re not taking on obligations that you cannot handle. A strong relationship with your banker is essential, especially for a small business. This relationship allows you to ask questions and fully understand the terms of the loan before you sign on the dotted line.
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Understand the Loan Documents
If you obtain a bank loan document, you should review it carefully. These documents can span many pages and include much more than the loan amount, interest rate, and repayment terms. They could potentially contain covenants — promises you make to the bank in addition to repaying the loan.
Examples of covenants include:
- Providing the bank with annual tax returns and quarterly financial statements
- Maintaining a specific bank account with a minimum balance
- Meeting certain debt-to-income or liquidity ratios
Violating any of these covenants could put you in default, even if you’ve made every scheduled payment. If that happens, the bank can demand full repayment of the loan.
Know What You’re Putting at Risk
Most business loans are secured, meaning you must pledge collateral. This collateral may include your business’s assets, receivables, or even the company itself. If you can’t repay the loan, the bank can seize the pledged assets.
Additionally, banks may ask you to sign a personal guarantee. This provision bypasses the liability protections of your business entity. If your company defaults, the bank can pursue your personal assets to satisfy the debt.
While a personal guarantee may be the only way to secure the loan, it comes with significant risk. Weigh this decision carefully and with an attorney’s guidance.
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Get Professional Guidance
Borrowing money can be the right move for your business, but it’s not without potential pitfalls. Consulting with a lawyer before signing a significant loan can help you:
- Evaluate alternative financing options
- Understand the legal implications of covenants and personal guarantees
- Identify the risks associated with your specific loan terms
At Richards Rodriguez & Skeith, we can help business owners evaluate borrowing options and protect their interests when negotiating with lenders. There may even be better alternatives for obtaining capital.
If you’re planning to borrow money for your business, contact us today. We’ll help you understand your options and ensure you’re making a decision that safely supports your long-term success.
