Starting a business and running a business is never an easy, nor cheap, exercise. Often founders look lovingly to family and friends (or perhaps financial institutions) to assist them in funding their fledgling business in its early days. However if you’re starting a new business it’s important to be careful when borrowing money. Whilst it is normal for businesses to borrow and lend money, the existence of a clear written agreement between borrower and lender is essential.
WHAT DOES IT COVER?
A Loan Agreement governs the relationship between borrower and lender and sets the terms and conditions for that relationship. A loan agreement will contain information about the amount borrowed, the repayment schedule and any information regarding interests, as well as what is to occur in the event of default and if any security is to be provided for.
Under these Agreements, the loan itself may be one of two types - secured or unsecured. Whether a loan is secured or unsecured depends on if the loan amount is held against an asset of the borrower, giving the lender an interest in that particular asset. Where this occurs, the loan is secured and it protects the lender from losing their invested capital where the borrower defaults on the loan amount. Where the loan is unsecured however, little protection is afforded to the lender in the instance of default by the borrower.
WHY IS THIS IMPORTANT?
A well-drafted and tailored Loan Agreement allows each party to know and fully understand their responsibilities regarding the loan. Having a clear loan agreement increases the chances of the loan being repaid on time and decreases the likelihood of future disputes. It also provides comfort to the lender in respect of securing its interest (if any) and outlines what recourse lenders can pursue in the event of dispute or default.