SCORE Small Business Blog

The Many Uncertainties of a Commercial Loan
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When a loan is first issued, the money is committed for the purpose of the loan.  These expenditures are most likely made within the first few months of the loan.  With the money available, there is always a high level of excitement, and progress is made to execute the purpose of the loan.

We can equate this to the purchase of a brand-new car.  When we purchase the car and drive it off of the car dealer’s lot, the car smells good, speedometer reads 0 miles, and it feels so much better than the old car.  The reality is that we have to make payments on this car for 36, 48, or 60 months.  In time the car loses its new-car smell and every day it starts to feel more and more like the old car.  As time goes on, it becomes a chore to sit down every month and write the loan check.  We get the same feeling when we have to repay a business loan, as the payment schedule continues on for several years.

Because of this commitment to the long-term, it is important that we ask ourselves a few questions:

What if the bank calls the note?

The bank will reserve the right to “call the note due.”  They will do this if there is any suspicion of derelict     practices discovered in the functioning of the business.  Reasons for the recall of the note would include the bank determining they are not in the first position against the assets, delinquency in payroll taxes, delinquency in loan payments, signs of embezzlement, etc.

What business insurance should I purchase to protect the loan?

If the loan extends for a period of years, our responsibility for the loan balance continues through the end of the loan agreement, or when the loan is paid off.  It is virtually impossible to foresee all of the surprises that may occur at any given time.  Therefore, it is important that we build in some protections that will provide for our survival if some of these uncertainties come to fruition.

What types of insurance should be considered for the protection of both the loan and the business?

Key man insurance - Most small companies are usually led by a key man that is involved in the everyday function of the business.  If for any reason, the key man is unable to continue this position, the company’s chance of survival is reduced.  This key man insurance might be requested by the bank as one of the requirements for granting the loan.

Catastrophic insurance – Catastrophes occur because of a storm, flood, fire, etc. Most of these occurrences will happen in a very short period of time, for which the business has very little time to react and can be of great consequence.  If this catastrophe closes down the business, the loan payments are not forgiven.

Embezzlement insurance – In a recent seminar that was given by our SCORE chapter on Business Insurance, the question was asked of the audience, how many of you have worked for a company that has experienced embezzlement?  The answer was overwhelming – one third of the audience had worked at a business in which there was a significant embezzlement.  In most cases, the owner of the company is too busy with other tasks and delegates his oversight of daily finances, and the temptations become apparent. Over time, these amounts become significant.

Loss of production insurance –Businesses have machinery or assets that are necessary for the success of the business.  If this piece of equipment or asset breaks down for a period of a week  or two or three, it has a direct effect on the cash flow of the company.   The bank loan does not provide for situations   like this.  The loan could be jeopardized and called due.

Then, as we pay off the loan for a year or two, more questions arise:

What happens if we need more money?

Is there hope of restructuring the loan?

The SBA will require that you pay off the original loan before you can borrow more money.

What I am trying to emphasize is the realization that there are so many uncertainties in the life of the loan.  It might be said that all of the effort that we put into getting the loan, may be thwarted by the uncertainties of maintaining the loan, but some of these uncertainties can be managed by proper planning by the business owner.  A business loan is important to the future of the business because it will affect its future banking relationship, credit scores that can be used by suppliers, credit card limits, and most importantly, your peace of mind when financial conditions are in order.

Dale JohnsonMentor, SCORE Southwest Florida
Within 2 years of becoming a SCORE mentor, Dale took over the workshop program of his local chapter and was elected Chapter Chair. His career included upper industrial management, industrial sales management, and owning three different small businesses.
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