Key issues of a loan agreement explained

Highlighting some key issues of a simple loan agreement

It is a truth universally acknowledged that an emerging company must be in want of a loan (first and last Austen reference in this blog, I promise). These loans come in all shapes and sizes, some even convert and they vary from coming from the family, friends and fools pool to being totally at arm’s length. What they all have in common though, is that they need to be put down in writing, preferable in clear text, to avoid any disputes over for example the timing and conditions of repayment of the loan.

We decided to include a template for a simple loan agreement in the Benvalor contract generator BEN. In this blog I will highlight some key issues of the loan agreement in general and this template in particular. The convertible loan is not a topic of this blog, if you want to learn more about this you might like to check out our blogpost on the EPOS.

Repayment loan agreement

A standard loan agreement can be a bullet loan or an amortizing loan (or a hybrid form of these two species). The characteristic of the bullet loan is that the principal sum has to be repaid at once and in full at expiry of the term of the loan agreement.
With an amortizing loan the principal sum is repaid in periodic instalments. The main differences of course being the amount of the monthly (or periodic) payments you have to make on the loan and the amount of interest you pay, depending on whether or not the principal sum diminishes.
Which type of repayment schedule you choose – assuming you even have a choice – is entirely dependent on the circumstances.

Interest

Simply put, a loan accrues interest. But how high – again, assuming you have a choice – should the interest rate be? If you have a choice, chances are that you represent both the lender and the borrower. This is the case for many directors and major shareholders who lend money to or from their own company.
The interest rate is one of the factors by which the tax authorities assess whether or not a loan agreement is on an arms’ length basis. Also other provisions such as the existence of any security for repayment and if the loan has been put down in writing are relevant.

If the loan agreement is qualified by the tax authorities as not being at arms’ length, this can have serious tax consequences. Consult one of Benvalor’s tax attorneys if you have any questions on this subject.

Securities

As a way to ensure repayment of the loan, the lender can demand certain forms of security. The most common forms of security seen in loan agreements are the suretyship and the right of pledge.
A suretyship (in Dutch: borgtocht) entails that another (legal or natural) person than the borrower will be liable vis-a-vis the lender to pay part or all amounts outstanding pursuant to the loan in the event of default of the borrower under the loan agreement. This provides the lender another party to recover the loan amount (and interest and costs) from.
A right of pledge (in Dutch: pandrecht) is a security on certain assets of (in this case) the borrower for the benefit of the lender, entailing that the lender has the right to sell the pledged assets in the event of default of the borrower under the loan agreement. Since depending on the types of assets that are to be pledged different formalities apply, the deed of pledge effectuating the right of pledge is not contained in this generator and will have to be drawn up separately (our attorneys will be happy to assist and we hope to have a generator for this in the near future too).

Another option is to include a clause that security will be provided on the first request of the lender (such an obligation is commonly referred to as a ‘positive pledge’ in the Netherlands). This does not effectuate a form of security at the time of signing of the loan agreement, but simply creates an obligation for the borrower to create security for his payment obligations under the loan agreement on the first request of the lender.

Security and interest are communicating vessels for the at arms’ length qualification of the loan agreement, meaning that the interest can be set at a lower percentage if a security is agreed upon.

Covenants

A level of influence and control is provided by a covenants clause where certain material resolutions (such as dividend payments, encumbering or transferring material assets and severe restructuring or limitation of the business) are made subject to prior approval of the lender. Thus giving the lender a (limited) level of influence on the borrower. In addition, the lender can be given some additional comfort by stipulating that he is given certain financial information and is informed of certain important resolutions (such as changing the articles of association and issuing shares).

Conclusion

With this additional information, there is nothing keeping you from drafting a perfect loan agreement. Or you can start with the one from our generous contract generating robot BEN. It offers a basic but solid loan agreement, that is ready to use after filling in some details of the loan in a few easy steps.

If you have any questions don’t hesitate to contact me or anyone of my fellow members of the Venture Capital team at Benvalor.

 

Marije van den Bergh

Attorneys and Tax Advisors