5 C’s of Credit (5 C’s of Banking)
How important is personal credit in negotiating a commercial loan?
Loan Origination Fee
What is a Term Sheet?
Preparing a Loan Package
Loan Term Definition
Loan term, defined as the period of time between when a loan is received and when the loan is fully repaid, is an important time in the life of any business. During the loan term, businesses must carefully watch finances as they have taken on a new liability which drains cash.
During the loan term a business experiences increased responsibilities. These include principal payment, interest payment, covenants (lender requirements), credit requirements, a certain risk to assets pledged as collateral for the loan, and more. All of these factors make the loan term a period of time in which a business must maintain professionalism. Though the loan term is explained above many people also casually refer to the covenants, or lender requirements which must be upheld for to avoid the lender revoking the loan, as loan terms.
Loan Term Explanation
Loan terms, explained simply, generally last up to ten years long. Loans shorter than one year are described as “short term” and loans with a life longer than one year are described as “long term”.
During loan terms, certain “covenants” must be upheld. Covenants, in short, are lender requirements which must be met to prevent the loan from revocation. Covenants start as simple as making interest payments and expand to requirements on debt and financial ratios of the business. As a rule of thumb, the more risk a lender experiences the more likely she is to extend loan covenants. Banks, in this manner, have more relaxed loan requirements than mezzanine debt financiers.
Additionally, the loan term becomes a big factor in matters of payment which are related to the loan. Logically, a short term loan in the amount of $1,000,000 will have to be repaid much faster than a 10 year loan amounting to the same sum. For tax purposes, loan terms have the same effect. A business can receive larger tax write-offs for a short term loan, though these write-offs extend to a longer period with a long term loan in the same amount. Though the loan term seems like a simple agreement related to when the loan is repaid, the effects extend into all matters related.
Loan Term Example
Chris is starting a web design firm. Chris, a student of web design and development since childhood, is an expert in his trade. He has, as luck would have it, found a great partner to market what he does best; create and manage usable web designs. Chris and his partner have had success as a startup, posses a growing collection of assets, and see company growth as their next horizon. They believe a loan will allow for this growth.
First, the two evaluate their options for a loan. Knowing that bank loans are usually some of the cheapest and simplest loans, the two young partners decide on using these. This is after they do their proper due diligence.
The two partners evaluate both short term and long term loans. They will begin by pacing their growth, so they decide on a small short-term loan. They realize that this decision should also be run by a tax accountant soon but decide to move forward for the time being.
The two convene to calculate the mathematics which effect the loan. They set expectations for the total amount, interest and principal payments, loan term, and future value of the loan. These factors, together, create the loan condition and provide insight into the expectations and limitations of the company.
Loan Term Sheet
They then begin courting bankers. In this process they discuss several key issues related to the loan term sheet: total term, term of covenants, terms by which if covenants are briefly missed the loan can stay in place, common loan terms for their type of loan, and more. They make sure to find a banker that is educated in his trade.
Now, the two consult with their accountant. The accountant provides useful insight into the deeper matters affecting their loan. Overall, their meeting is a valuable and encouraging lesson. This is much more effective than scouring the web for a “loan payoff calculator”.
The partners eventually receive the loan they desired. They did this with the basis of understanding the environment around their loan. They are confident that if they continue to plan their business operations they can avoid costly mistakes and can create a future for themselves. Loan term amortization is not as frightening as it once seemed.
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