Why Secured Loan Commercial Lending Covenants Matter

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Commercial lending in Canada, when it comes to a secured loan typically always involves ' COVENANTS '. What are they and how do you address the pitfalls and dangers of this method that lenders use to protect themselves (and you by the way) from business default and failure. Let's dig in.

COVENANTS ARE NEGATIVE AND POSITIVE

When it comes to the agreements you make with any secured lender in Canada it basically comes down to the ' yay' and ' nay'. What we are talking about is known as ' affirmative' and ' negative’ scenarios. Affirmative actions are those you can take or do, sometimes with permission required. Negative ones are those which you are unable to take in the normal course of running your business.

WHAT ISSUES AFFECT YOUR LOAN COVENANTS

What are the typical scenarios that the Canadian business owner or manager takes that might affect your loan agreement? They might include:

Raising more equity capital

Selling certain assets of the business

Taking on debt (that’s a big one with lenders!)

Draining cash flow in some manner

Remember always that the proactive thing to do is to discuss actions you wish to take that affect the lending agreement. When they are common-sense business actions they will almost always be allowed by a (reasonable) lender. A good example might be taking on more debt by acquiring new production equipment or technology that makes your business more profitable.

NEGOTIATING COVENANTS!

The thing about loan covenants for small businesses that is often missed by the borrower is that while the loan covenants generate a lot of discussion and negotiation ( yes they can be negotiated!) at the start of loans they must in fact be maintained during the duration of the secured loan / commercial lending arrangement.

So what happens when you are those covenants are breached? The harsh reality is that you are in default of your commercial loan and typically all monies are due.

WHAT TYPES OF FINANCING HAVE FEW OR NO COVENANTS

We point out to clients that many types of loans in Canada have no or very few loan covenants, especially in the area of alternative funding. Examples typically include asset-based lines of credit, receivable financing, equipment finance, tax credit monetization. If there are any covenants in those types of arrangements it's typically because your overall balance sheet and income statement dictate that.

Remember also that all arrangements defined in your loan agreements are not necessarily negative. For example, if you can negotiate pre-payment arrangements in your favour that’s a good thing. Also, certain actions you take might make sense for you and the lender to pay down loans - for example new equity or sale-leaseback scenarios with another lender.

WATCH FINANCIAL RATIOS!

The huge issue around business loan and commercial lending agreements with lenders in Canada is ' RATIOS '. Lenders have a lot of guys in the backroom constantly running liquidity, leverage and Operating ratios on your business. You can proactively manage these ratios in a positive manner by understanding what they are and calculating them yourself - Trust us it's not that easy.

CONCLUSION

When it comes to commercial lending and secured loans that make sense to you (and the bank or commercial lender) seek out and speak to a trusted, credible and experienced Canadian business financing advisor who can assist you with your secured loan needs.

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