Need Help Paying Back a Business Loan? How to Negotiate New Payment Terms
It’s crucial that you understand all of your loan terms, and negotiate better ones when you can. Here’s a list of the most common loan terms you should know, and the terms that are most important to negotiate.
Here's what you need to know:
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Common loan terms you should know include repayment term length, borrowing mechanics, calculation of the borrowing base and discount factor, cash dominion, calculation of Debt/EBITDA ratio, and affirmative and negative covenants
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Think about negotiating the minute you start thinking about applying for a loan
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When negotiating loan terms, choose the right lender, dress up your business, use sound arguments, and utilize competition to your advantage
Every business borrows. Even if you don’t have a line of credit or a traditional bank loan, we’re guessing you still buy on credit or defer payables from time to time. And access to credit can make the difference in whether your business survives or dies, especially in these uncertain times.
But before you sign on the dotted line, it’s important that you understand all of your loan terms — and negotiate better ones whenever possible.
What are the important loan terms to be aware of?
Every business loan or line of credit has terms for borrowing and repayment. Here’s a list of the most common loan terms you should know, and the terms that are most important to negotiate.
Repayment term length
Most Small Business Administration loans have repayment terms ranging from less than 6 years to 25 years. Traditional bank loans are usually paid back in 3 to 10 years. And business lines of credit can run 6 months to 5 years. You can easily negotiate your repayment terms within those established windows.
Borrowing mechanics
This term refers to when and how the bank gives you borrowing notice, and when you get your money. This is one of the most common terms to negotiate.
Calculation of the borrowing base and discount factor
A borrowing base is the amount of money that a lending institution is willing to loan your business based on the value of your collateral. Typically, your lender will calculate your borrowing base using a method called “margining.”
In margining, the lender calculates a discount factor based on how much of a risk they perceive your company to be, then they multiply that discount factor by the value of your collateral. For example, if the lender determines that your company is very low risk for defaulting on the loan, they might decide that your discount factor should be 90%.
Let’s say you offer up $100,000 worth of collateral. The bank will lend you a maximum of 90% of $100,000, or $90,000. Obviously, if you get a higher discount factor, you’ll be able to borrow more money without having to put up more collateral, so this is an important term to negotiate.
Cash dominion
One typical feature of asset-based loans is that they require cash dominion. This means that you must sign a controlled account agreement so that your company’s receivables enter into a lockbox. The funds then flow from the lockbox and are used to pay down your loan. In other words, the lender has control of your cash. (Middle market loans do not require cash dominion.) You may be able to negotiate how much of your cash goes into the lockbox by excluding certain receivables.
Calculation of Debt/EBITDA ratio
Your Debt/EBITDA ratio measures the amount of income you have available to pay down your debt versus the amount of debt you hold.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Your Debt/EBITDA ratio measures the amount of income you have available to pay down your debt versus the amount of debt you hold. A high ratio means that your company’s debt load is too high. Lenders often include a debt/EBITDA target in the covenants for business loans. You must agree to maintain that level, or your entire loan will become due at once. Needless to say, you don’t want that to happen. That’s why it’s important to negotiate a Debt/EBITDA ratio that is doable for you.
Affirmative covenants
These are actions that your company agrees to take after entering into the loan agreement. These might include:
- Giving your lender notice of any adverse events
- Delivering certain financial information
- Allowing the lender to enter and inspect your place of business and your records
- Maintaining certain insurance coverage
- Compliance with certain laws
Of course, some of these terms are non-negotiable, such as complying with the law, so your lender will automatically include them. But you might be able to negotiate some of them away, if you can show that they are redundant or unnecessary. Alternatively, you might want to consider offering up additional affirmative covenants in order to get a lower interest rate.
Negative covenants
These are the opposite of affirmative covenants. They are actions you agree NOT to take while you’re paying back your loan. For example, your loan terms may require that you not borrow money from other lenders. They may also limit the amount of dividends you may pay your shareholders, or place a cap on executive salaries.
In general, more negative covenants mean a lower the interest rate on the loan, since the negative covenants make the loan safer for the lender. You might be able to negotiate lower interest terms by offering up more negative covenants. Just be sure you don’t agree to restrictions that are too tight, or will impair your ability to do business.
When is the best time to negotiate loan terms?
You should be thinking about negotiating the minute you start thinking about applying for a loan.
You should be thinking about negotiating the minute you start thinking about applying for a loan. If you know of particular terms you will want included in your loan, mention them immediately in your initial phone calls and emails with the bank.
But once the application process has begun, that’s when the real fun starts. You will get a proposal or commitment letter, along with a term sheet, from the lender. The term sheet will include lots of details, including schedule payments and prepayments, collateral, covenants, and default terms.
Most lenders use a lot of “boilerplate” language in their loan terms. This streamlines the process by using the same language in every loan. But it’s a mistake to just skip over this language and assume it works for you. Boilerplate terms are standard for a reason. They overwhelmingly benefit the lender.
So review the terms thoroughly, and mark up the term sheet with your requests. (If you don’t think you fully understand the terms, this is the time to engage with an attorney.)
Be sure you are able to answer the following questions:
- Can I borrow the amount I need?
- Can I get the money when I need it?
- How will I get the money? Does that work for my business?
- Am I capable of providing the financial reporting that the loan terms require?
- Do the covenants prevent me from entering into transactions that my business can’t live without?
If the answers to these questions don’t work for your business, that means you have an item to negotiate. Try to focus only on the most important loan provisions. This can save you a lot of money in attorney fees, and it will offer you the most bang for your buck.
How to negotiate loan terms
Here are a few tips for negotiating loan terms with your bank:
Choose the right lender
Before you even apply for a loan, do your research. Most banks specialize in a particular type of loan. For example, some may loan primarily to restaurants, while others never loan to restaurants. Be sure you’re applying for a loan with a lender who is able to service you.
Dress up your business
Preparing for loan negotiations is a lot like getting ready for a big date. You want to look your best. And we don’t just mean wearing a nice suit.
It’s important to appear well-prepared with your paperwork. When you arrive for your first meeting with your loan officer, you should bring the following:
- A personal financial statement that lists your income, assets, and liabilities
- Copies of your credit report
- 6 months of bank statements
- Recent broker account statements
- Copies of all insurance policies that relate to your business
- Information on any trusts you hold
- Any recent appraisals you’ve had done
Be sure your paperwork is in order, and that it presents your business in a positive light. First, try to repair and remove negative items on your credit report, tax returns, bank statements, or other financial documents. If this is not possible, prepare a letter of explanation for the bank.
And don’t discount the importance of neatness and good writing. Grammar, spelling, and organization counts. If your documents look sloppy, the lender will think you look unprofessional, and might not even review them.
Be sure your paperwork is in order, and that it presents your business in a positive light. First, try to repair and remove negative items on your credit report, tax returns, bank statements, or other financial documents.
Use sound arguments
Most likely, the lender will try to impose as many restrictions as possible, right from the beginning. If there are restrictions that don’t work for you, address each one individually and ask the lender to either eliminate or relax it. You can use one or more of the following arguments:
- Your company needs financial flexibility to avoid defaulting on the loan
- Some of the covenants are redundant. The lender can drop one altogether and still meet their goals with the remaining covenants
- If your company has a strong balance sheet, point out that your assets can be used as a secondary source for repayment in the event that your future earnings don’t pan out
- If you don’t have a strong balance sheet, talk up your earnings outlook. You might be able to argue that you’ll still be able to make your payments because your future earnings will make it possible to refinance
Use competition to your advantage
A lot of larger companies shop around for loan terms by requesting bids from several banks. If you choose to do this, you would ask each lender to quote you an interest rate, repayment provisions, and their list of restrictive covenants. When you make this request, many banks will respond by proposing their most favorable possible terms.
However, this strategy does have the potential to backfire, especially if you have a small business with low earnings. But you can do this in a modified way. Before you apply for a loan, reach out to lenders and have a conversation about the types of covenants they usually require. Once you have this information from several banks, you can mention it while negotiating with whichever bank you finally choose. That may motivate them to loosen their restrictions.
