What is a business loan agreement?

The business loan agreement includes your interest rate, who is responsible for the loan, collateral, when it can be seized and other significant details. Understanding each part of the business loan agreement will set you up for success throughout the life of your loan.

Important parts of a business loan agreement

Being approved for a business loan is great, but you need to sign the business loan agreement before you can receive the funds. A lender, like a bank, credit union or alternative lender, traditionally draws up the business loan agreement.

As business loan agreements have several parts, you must understand what you are signing. Common provisions in the agreement cover how collateral is handled, interest rates and any changes that may occur if parts of the business change.

Promissory note

The promissory note is a basic outline of the loan. It includes how much money the loan is for, the interest rate, the payment schedule and when the loan agreement ends.

Collateral

Not all loans include collateral, but if yours does, the loan agreement will include information about the collateral and when it can be seized. Collateral secures the loan and is anything the lender can seize if you default. This can include real estate, business equipment or cash.

Interest rate

The loan’s interest rate is essentially the cost of borrowing from a lender. Your rate may differ depending on your business credit score, the age of the business, the loan’s size and your collateral.

Before you sign on to a specific interest rate, make sure you shop around with multiple lenders to determine if you are getting the best rate.

Potential changes

Sometimes your business structure changes, or the lender may undergo management changes. The loan agreement should outline what happens to the loan if things like this happen. Educate yourself on what types of changes could result in the end of your loan agreement or a change in payment amount.

Common terms and conditions

Knowing common terms is helpful when reading through the business loan agreement. This is not an extensive list, but here are a few common business loan agreement terms to familiarize yourself with:

• Personal guarantee: With a business loan, this provision in the loan agreement states that you will take personal responsibility if the business defaults on it.
• Prepayment penalty: In some cases, the lender may charge an extra penalty fee if you repay the loan early. This is called a prepayment penalty.
• Default: When you miss multiple payments on the loan repayment schedule, the lender can put your loan in default.
• Late payment penalty: When you miss the payment deadline as agreed upon in the payment schedule, the lender may charge a late payment penalty.
• Blanket lien: This term states that the lender can seize any part of the business if you default on the loan.

Business loan agreement red flags

Reading through the business loan agreement can help you spot any red flags. You don’t want to sign any agreement that sets you up for failure, that your business likely won’t be able to adhere to or makes you feel uncomfortable. It may be a bad sign if:

• The lender pressures you to sign the agreement quickly.
• They are requesting money upfront, and it isn’t noted anywhere.
• The loan has a variable interest rate, which can change your payment significantly.
• The loan payments are higher than your current cash flow needs can cover.

In general, you want to avoid any signs that something is off with the lender. The loan agreement should be clear, and the lender should be able to answer any questions you have.

The bottom line

A business loan agreement outlines everything about the loan and its repayment terms. Before you sign one, make sure you understand everything it says.

It can be tempting to skim through the agreement, but carefully looking through the fine print will help you understand your loan to ensure you’re getting the best small business loan. Look out for details that put your business at risk or ask you to agree to things you aren’t comfortable with.

Frequently asked questions

• What is the main purpose of a business loan agreement?

  A business loan agreement explains all of the terms and conditions of the loan so that both the borrower and lender understand how the loan will be handled. This includes the repayment schedule, interest rate, loan amount, collateral and default terms.

• What is an LLC loan agreement?

  An LLC loan agreement details the loan terms of a business loan for a limited liability company (LLC). The structure of an LLC limits the business owner’s liability. An LLC loan may include a personal guarantee provision to get around these limits of liability.

• What are the two parties called in a loan agreement?

  A loan agreement is made between the lender and the borrower. The borrower in a business loan agreement would be the business. The lender may be a bank, credit union, online lender or financing company.