Loan Agreements: Borrowing Without a Bank
Small businesses and start-ups often struggle to grow due to lack of capital. Borrowing from family or friends is an alternative.
Borrowing from family or friends is best conducted in a business-like manner i.e. you should set out a proper business case. In the current economic climate, more than ever, getting a loan for your business should be a formal transaction with a legally binding loan agreement, even if you're not borrowing from a traditional lender like a bank. In this way the terms of the business relationship are clearly set out and all parties understand what has been agreed.
There is no legal requirement to record a loan using a written loan contract but it does help ensure that both parties are equally aware of their rights and responsibilities.
A loan agreement doesn’t have to be complicated. The key things to include are:
- The names of the parties to the agreement – the borrower and lender
- The amount of money being borrowed
- The interest rate being charged (if any) and how it is calculated
- Repayment terms – the amount and frequency of repayments (instalments)
- A prepay clause if you want to impose a fee for early repayment of the loan.
A loan that is for a fixed term with a specified repayment schedule (e.g. monthly payments) is known as a term loan. This is the type of loan we're considering here. The other main type is a revolving loan like a credit card or overdraft facility.
Rate of Interest
The rate of interest applied to a loan is often expressed as a nominal rate above the published annual base rate of particular bank (e.g. Barclays Bank). If the annual base rate changes during the course of the loan then the repayment amounts may need to change for the loan to be repaid within the term. Your loan agreement could include clauses to allow the instalments to be varied or the term extended or reduced to take account of changes in the base rate during the term of the loan. If you aren't going to charge interest then this needs to be clearly stated.
For a simple fixed term loan, the repayments are usually equal amounts payable at regular intervals. The repayment amount needs to be correctly calculated so that the loan and interest is paid off in full at the end of the term. If you're going to calculate the repayment amounts yourself then make sure you calculate it correctly. There are plenty of free online loan calculators to choose from that will do the calculation for you.
Security a Loan with an Asset
If the borrower offers an asset as security for the loan then the loan agreement will need to include a description of the asset and clauses covering ownership, insurance, inspection and disposal of the asset. The purpose of providing an asset to secure the load is that if the borrower doesn't repay the loan then the lender can sell the asset to recover the outstanding amount.
For some loans you may wish the borrower to provide a guarantor i.e. a third party to guarantee repayment of the loan. In this case, the guarantor would need to be named in the loan contract and a clause included stating the guarantor guarantees repayment of the loan. If the borrower fails to repay the loan then the lender can pursue the guarantor for repayment.
Drafting a Loan Agreement
So, the simplest form of loan agreement you can use would be a fixed term loan without security or guarantee. You could use a solicitor, draft it yourself or use a loan agreement template. There are also plenty of on-line providers of loan contract templates, including Clickdocs. However you choose to draft your loan agreement, make sure it is correctly signed and witness and store your copy in a safe place.