Key Finance Terms

Key Terms to Consider When Choosing a Finance Solution

When Enterprise Financial Partners assists companies with their commercial loan and finance needs, we want our clients to have a basic understanding of some of the more common terms and requirements of the lenders with which we work. To help ensure that this is the case when seeking these types of lending arrangements, we have put together the following list and description of certain key terms you’ll want to consider when choosing a commercial loan or financing arrangement:

Interest Rates and Swaps

Interest rates on business credit facilities are typically variable with those of larger and financially strong companies often based on a pre-determined spread over the 30-day London InterBank Offered Rate (LIBOR) or the lender’s base or prime rate. Fixed rate loans, however, are normally quoted on the basis of a spread over a comparable Treasury note or the lender’s cost-of-funds or swap rate. Rates on certain higher-risk loans (e.g., mezzanine loans) are typically based on the lender’s targeted rate of return for the perceived level of risk undertaken.

Companies with floating rate loans are often able to hedge some or all of their exposed variable rate debt through the use of an interest rate swap. An interest rate swap is a financial instrument representing a transaction in which two parties agree to swap or exchange net cash flows, on agreed-upon dates, for an agreed-upon period of time and for interest on an agreed-upon principal amount. For example, one party might agree to swap floating-rate payments with the fixed rate loan payments of the other party, with the net effect being each party getting the benefit of the other’s interest rate.

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Advance Rate on Collateralized Loans

Loan advance rates on non-real estate collateralized loans (e.g., asset based and equipment loans) often vary from creditor to creditor and differ depending on the financial strength of the company involved. When it comes to asset based loans, most lenders and finance companies will advance 75 percent to 85 percent of a company’s eligible accounts receivable, and 40 percent to 60 percent of its eligible inventory. As for equipment, depending on the type of equipment, its condition and the term desired, lenders will typically lend from 75 percent to 90 percent of the equipment’s cost or value. Value, however, could be defined as either market value or orderly liquidation value depending on the lender involved and the company’s financial ability.

If a company needs to maximize cash and desires 100 percent or more financing on equipment, it may need to look at the various leasing options available. Most leasing companies typically have programs that allow the company to finance up to 100 percent—or more—of the asset being acquired. There are a variety of lease programs available to our clients, with the most common being operating leases and capitalized leases. If this is something you’re interested in, you should consult with your CPA or accountant to determine which type of lease best serves your tax needs.

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Credit Agreements and Affirmative/Negative Covenants

Most significant credit facilities come with credit agreements that often require a company to make certain affirmative and negative covenants and other agreements relating to activities the company may or may not engage in during the term of the loan or financing arrangement. For example, most of these agreements provide that the company prepare and remit interim and annual financial statements—the latter often audited—to the lender, as well as various forms of borrowing base certificates or other forms of compliance certificates, to allow the creditor to monitor the company’s on-going financial health. These agreements may also provide that certain financial covenants (or ratios) be maintained, such as a minimum net worth or a periodic cash flow coverage ratio—all of which are normally customized to your specific situation.

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Limited vs. Full Recourse Guaranties

For larger, established companies, personal guaranties from principal owners or sponsors are often not required for commercial loans. However, in those situations whereby the lender does require principals to provide some form of personal guaranty—a guaranty of payment in most cases—the principals can sometimes negotiate a limited guaranty specifying a certain dollar amount or a percentage of the outstanding loan balance, or they may only be required to sign a guaranty of collection. While not always a preferred method of guaranty from the lender’s perspective, a guaranty of collection is a form of guaranty that essentially provides that the lender must first collect all they can from the borrowing company before coming after the guarantor.

One other option that may be available in certain circumstances is a so-called fraud guaranty. Under this form of guaranty, the individual or entity signing would generally only be liable to the lender to the extent certain fraudulent activities took place during the term of such guaranty. In all other cases, the lender typically requires full guaranties from all principal owners of the borrowing company or some other qualified credit enhancement; this is especially true for newer, smaller and undercapitalized companies.

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Prepayment Limitations

Many fixed rate term loan and lease facilities often have some kind of prepayment limitation or penalty associated with them in the event of early prepayment. These prepayment limitations and penalties may take the form of, respectively, no prepayment during the first year of the loan or lease and the payment of a certain percentage of the loan’s principal balance (e.g., 2 percent of the loan balance), or the penalty may be determined through the use of a yield-maintenance formula. Certain extended-term asset based loans also typically carry with them prepayment restrictions that won’t allow a company to terminate the credit facility at all without imposing some form of early termination fee.

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Assumptions

While most business credit facilities don’t normally provide for third-party assumptions per se, some lenders will allow their notes to be assigned to other qualified companies in certain circumstances. Most notably, these scenarios are typically allowed whenever it’s in the best interest of the lender to allow the assignment to take place. In other words, when a company’s financial health has deteriorated and the new party to the relationship provides an additional enhancement to the credit relationship. Under normal circumstances, however, a company shouldn’t expect this to be an option in most situations.

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