Tag Archives | loan

Self-Liquidating Loans

See Also:
Loan Agreement
Collateralized Debt Obligations
When is an interest rate not as important in selecting a loan?
Debt Ratio Analysis
Debt Service Coverage Ratio (DSCR)
What Your Banker Wants You To Know
7 C’s of Banking
Budgeting 101: Creating Successful Budgets

Self-Liquidating Loans

The term “self-liquidating loans” is banker slang. It refers to a loan that is used to generate proceeds that are in turn used to repay the loan. Basically, a borrower takes out a loan used to finance business activities that generate revenue. Then the borrower takes the revenue generated from those business activities and uses it to repay the money that was borrowed to finance the activities.

Self-Liquidating Loan Example

The term can apply to a company that experiences seasonal fluctuations in business. During the busy season when business is booming the company needs to borrow money to finance short-term assets such as inventory and accounts receivable. The company borrows money to buy more materials to take advantage of the increasing demand of the busy season.

Then when business slows down the company will have less of a need for borrowed funds to finance short-term assets like inventory accounts – the need for financing will decline as the need for inventory declines. At this point, the company will have generated profits from the busy season, and will now be able to use those profits to repay the loans it took out to finance operations during the busy season. And this is called a self-liquidating loan.


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self-liquidating loans

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self-liquidating loans

Source:

Higgins, Robert C. “Analysis for Financial Management”, McGraw-Hill Irwin, New York, NY, 2007.

 

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Secured Claim

See Also:
Pledged Collateral
Collateralized Debt Obligations
Debt Ratio Analysis
Debt Service Coverage Ratio (DSCR)
Convertible Debt Instrument
Asset Based Financing

Secured Claim Definition

The secured claim definition is debt backed by collateral. It can refer to loans, mortgages, bonds, and other financial debt instruments.

As stipulated in the debt contract, the debtor backs the debt with assets that the creditor may claim in the event of default. In a secured claim contract, if the debtor defaults, or is unable to payback the debt, the creditor can take ownership of the collateral and sell it to pay off what the debtor owes. For example, if a consumer defaults on a mortgage, the bank can claim the house and sell it to pay off the consumer’s debt. In the event of default, the secured claim is worth only as much as the collateral that backs it.

In contrast, unsecured claims are debt contracts or instruments not backed by collateral. Secured claims are considered less risky. In addition, these contracts or instruments offer lower yields. In comparison, unsecured claims are more risky. These contracts or instruments offer higher yields to compensate the lender (or investor) for the higher risk.

secured claim

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Preparing a Loan Package

See Also:
Can Factoring Be Better Than A Bank Loan?
Loan Term
Prepare an Investor Package
Good Budgeting Processes
What the Banker Wants You to Know
Does Your Management Team Understand the Financials?

Preparing a Loan Package

Knowing the process of preparing a loan package can be one of the most resourceful tools for business owners. Many feel loan package preparation is overwhelming and even frustrating if you are unsure of what to include in the loan package. Knowing the right time to apply for a loan to help grow or sustain your business is very important when planning your financial future; however it is only a part of the whole. The other piece of this puzzle is familiarizing oneself with the loan package requirements in order to secure the loan.

In the Lender’s Shoes

Before we consider the details of organizing a loan package, let’s put ourselves in the lender’s shoes. What would be some of the risk factors needing to be addressed before lending money to this particular borrower? This person will ultimately have to sell you on the idea that their business is worth investing in and the return on their investment is worth those risks.

After they have sold you on this idea, now it’s time to discuss the terms and conditions of the loan they are requesting. This is where the question of “how much” is answered and the repayment plan is offered.

Lastly, being that we are all so busy, time would probably be of the essence. Therefore, it would be very important for them to cut to the chase when convincing you that this investment you are making into their business is a win-win relationship for both parties. In short, in order to prepare a loan request, it is important to have a thorough presentation, but in the same manner getting to the point of the matter is essential.

Thus far, we have covered a general overview of preparing for a business loan. Now let’s get into some of the details of the documentation contained in the loan package.

Loan Package Template

1. Loan Request
2. Description of Company
3. Product and Services
4. Marketing Plan
5. Operational Plan
6. Management and Organization
7. Financial Plan
8. Appendixes

This template is the skeleton for the body of content needed when it comes to knowing how to organize a business loan package. It is an excellent guide regardless of the reason for the request. It does not matter where you are in the development of your company, be it start up, looking to expand, or wanting to improve on the sales and services. Seeking outside funding is a key part of that process. Answering the questions of “where do I go to get the money needed” or “when is the right time to apply for a loan” serves as a non-issue with most owners or CEO’s. However, the answer to the question of “how do I prepare a loan package” is not as obvious.

Loan Request Outline

The loan request outline included in this article will definitely get you started and moving forward on the right track. However, keep in mind the three main points:

1. Sell your Company
2. Discuss the Payback Plan
3. Time is of the Essence

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Preparing a Loan Package
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Preparing a Loan Package

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Negative Equity

See Also:
Working Capital From Real Estate
Asset Based Financing
Loan Agreement
Pledged Collateral
Collateralized Debt Obligations

Negative Equity Definition

The negative equity definition is when the the value of a loan is more than the value of the assets used to collateralize the loan. In addition, negative equity loans usually occurs because the value of the assets has diminished over time.

Negative Equity Explained

Negative equity usually occurs in the real estate market with mortgages. When the price of the house drops from a recession or some other reason, this causes negative equity. It often means that a home/land owner is actually paying more for the house/land than what the asset is actually worth. Also, if the borrower defaulted on the negative equity debt, then the lender would not recoup the amount given simply through repossession.

If the loan is a recourse, then repossession is not the only means of recouping costs. The bank or lender can go after recourse debtors after they sell the asset.

If the loan is non-recourse then it means the creditor will only be able to recoup some of its costs through the sell of the asset. This type of equity has also been known to occur if the value of the collateral asset stays fixed, and the value of the loan payments is less than the interest of the loan. Refer to this negative equity as a negative amortization.

Negative Equity, Negative Equity Definition

 

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Mezzanine Debt Financing (Mezzanine Loans)

See Also:
Recapitalizing Your Company Using Mezzanine Financing
Angel Investor
Venture Capitalist
Why Venture Capital
What is a Term Sheet

What is Mezzanine Debt Financing (Mezzanine Loans)?

Mezzanine debt financing is a subordinated and unsecured loan which typically features a warrant. This type of debt has higher interest rates because of its subordinated and unsecured status. It is not backed by collateral. In the event of debtor default, the claims of mezzanine lenders are senior only to the claims of common shareholders. Therefore, use mezzanine debt to finance startup companies with growth potential or to complement other forms of debt in a leveraged buyout.

Like other debt instruments, mezzanine debt includes a contract that stipulates the details of the loan. The contract describes the amount of the loan, the rate of interest and the interest payment schedule, the due date for principal repayment, and whether or not there is a conversion feature. The loan may also allow a portion of the interest payments to be accrued over the life of the loan and paid along with the principal at maturity. This feature is payment-in-kind.

Interest rates on mezzanine loans are substantially higher than other types of loans. This is to compensate the lender for the riskiness of making a subordinated and unsecured loan.


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Mezzanine Lender

Mezzanine lenders are often private equity funds or venture capitalists. Therefore, consider these mezzanine loans speculative investments. The debt instrument provides a stream of income and some downside protection, while the warrant feature offers the potential for upside gains.

Advantages and Disadvantages of Mezzanine Debt Financing

For borrowers, mezzanine debt financing allows companies with less collateral to secure funding for growth. On the other hand, the interest rates on this type of loan are comparatively high. So it is expensive source of capital.

For lenders, mezzanine debt instruments offer higher yields than secured or more senior forms of debt. Also, the warrant feature offers the promise of gains if the borrowing company’s equity increases in value in the future. On the other hand, there is a greater risk of default because the claims are subordinate and unsecured.

Mezzanine Capital

Mezzanine capital refers to subordinated and unsecured debt or preferred equity. It often includes a warrant, or a conversion feature, that allows the lender or investor to convert the debt or preferred stock into a specified quantity of the company’s common stock at a set price within a stated period of time.

Equity Warrants

The equity warrant feature of mezzanine capital allows the lender or investor to convert the loan or preferred stock into a specified quantity of the company’s common stock at a set price within a stated period of time. Design it to give the lender or investor an equity stake in the possible future success of the company.

Mezzanine Meaning

The word “mezzanine” derives from the Italian diminutive form of the word “middle.” Use it to describe the lowest balcony in a theater.

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Mezzanine Debt Financing, mezzanine loans
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Mezzanine Debt Financing, mezzanine loans

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Market Rate

Market Rate Definition

The market rate, defined as the rate of interest, on a loan or investment, which is commonly available on the market for that product, defined the cost of benefit of the tool. For a loan, the market rate is the average rate of interest that will be charged to the receiver from a variety of providers. To the investor, the market rate is the average rate of interest gained from all or a certain set of investment vehicles which are available on the open market. These create the market rate of interest definition as a whole.

Market Rate Explanation

Market rate, explained as the rate to expect when seeking out an interest bearing tool, is the estimated average of all of the vehicles available. This, as listed above, can be applied to both loan and investment instruments. The market rate of return definition should be understood before the search begins.

Better than or worse than market rates are available. These, however, are the statistical anomaly. Market rate is what should be expected. When a party finds a more favorable rate it should first check other factors. If these do not decrease the benefit of use, the tool with the more favorable rate should be used. This requires market rate analysis to check the validity of each deal.

Market Rate Example

For example, Dwight will soon be receiving 2 market rates: the market rate on a loan for his business and the market rate for his investments. Dwight pays close attention to the market rate of return because he can create an expectation of both cost and benefit from it. He thinks his actions through.

First, Dwight looks for the market rate of loans. Soon after this research, Dwight finds a lender who is asking for less than the market rate. His research has paid off and he takes the loan.

Next, Dwight looks at the market rate vs coupon rate for a bond he may purchase. In this comparison, he evaluates the market rate of return on stock he may purchase. Deciding that more stock is too risky, Dwight relies on his research and opts to buy the bond. He appreciates diversification over the highest interest rate.

Dwight also looks at the market rate of return cash balance he has gained from employee benefits he used to receive. He is happy to receive that he is running average. This tool will be useful for his retirement planning.

Dwight relies on his research. Rather than assuming, he lets the market and his sense of judgement decide for him. Dwight has been a success so far and it seems he will continue to be one.

Market Rate definition

See Also:
Delivery Order
Financing Lease
Lower of Cost or Market (LCM)
Excess Insurance Wiki

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Loan Term

See Also:
Loan Agreement
5 C’s of Credit (5 C’s of Banking)
Self-Liquidating Loans
How important is personal credit in negotiating a commercial loan?
Loan Origination Fee
Term Deposit
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.

Evaluate

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.

Calculate

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.

Conclusion

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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Loan Term
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Click here to learn more about SCFO Labs

Loan Term

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