Funding business growth through debt: A guide for your business




 

Most business owners may need access to finance when it comes to growing a business. It might be to help purchase stock-in-trade, or buy plant, equipment, vehicles or other assets used in operating the business. 

Funds might come from a private investor, but more often, it involves borrowing from a third party, usually a bank.

When you are comparing your options for a business loan, you may see similar legal terms used in the fine print. 

It is a good idea to understand what the legal and financial implications will be for your business. 

As you examine each arrangement, it is helpful to understand the correct meaning of the terms used. (It is also recommended that you obtain financial advice from an accountant).

When raising funds through debt, there are two key words that may help your understanding. They are ‘loan’ and ‘security’.

In this article, we examine what is meant by ‘security’ and how these are relevant when considering taking on a business loan.

 

What is security?

The term ‘security’ refers to a bundle of rights, promises and obligations over something of value that the borrower offers a lender in consideration of the advance of moneys on loan.

Examples include a personal guarantee and indemnity by the owners of the business (or directors of the trading company) or a security interest in personal property under the Personal Property Securities Act 2009 (Cth).

When considering whether to advance any moneys on loan, the lender may make some enquiry into the borrowers’ financial capacity to make payments as and when they fall due and payable, including repaying the full amount outstanding should the loan need to be called in. 

Once a lender agrees to advance moneys on loan then the terms of repayment, interest payments, etc., is a mere promise by the borrower to repay those amounts as when they become due and payable under the loan agreement.

A lender might be lending money for a long period of time, usually over a number of years. During that time, there are an infinite number of events that could happen that may affect a borrowers’ ability to repay a loan. 

Security is in addition to a borrowers’ promise to repay the loan under the terms of the loan agreement. 

Therefore, you may be asked you to provide security for a business loan. 

A lender who lends money using business assets as security (such as vehicles, equipment, or machinery) can register its security interest on the Personal Property Securities Register (PPSR).

 

How is a mortgage different?

Often people talk about not owing any money under their mortgage. The term ‘mortgage’ is not to confused with the term ‘loan’. 

A ‘mortgage’ is a specific type of security where the borrower grants the lender a bundle of rights, promises and obligations that creates an interest in land. 

For example, your business might use a loan to buy new premises, which will usually be secured by a mortgage over the property. If your business already owns the business premises, then a borrower may be asked to mortgage the premises in favour of the lender. Sometimes guarantors may be asked to give a mortgage over their home or an investment property, as security for your business loan.

Each state and territory in Australia has a land registry that records the legal description of the land the proprietor of that land and who has registered interests in that land. 

A mortgage over real estate will therefore need to be registered – which means it will also need to be in the prescribed form for registration. 

 

Formalities

When you take out a loan there are usually two key documents involved:

  • The loan or facility agreement. This sets out the details of your loan – how much you are borrowing, the type of facility on offer, the term of the loan, how interest is calculated and when repayments are to be made.
  • The mortgage or security deed. This is the document that records the interest over the specified security in favour of the lender. 

These are important documents, so it is important to understand your rights and responsibilities under each one – and to know what could happen if you are unable to make payments as and when they become due and payable. 

A lender will also want to make sure the borrower understands what they are agreeing to, so will often require you to take independent legal and financial advice before signing up the loan and security.

Situations may arise where a borrower may seek to to restrict or cease the obligations under the security. For example, where the borrower:

  • Plans to sell the secured property (for example, if you are selling your business).
  • Seeks to raise finance from another lender.
  • Pays off the loan and seeks to discharge the security.


 

Getting it right for your business

Entering into a loan and raising finance to operate and grow your business is an important transaction to get right and requires careful consideration and advice before ‘signing on the dotted line’. 

That is because, when you agree to use your business or personal assets as security, the consequences are serious if you default on the loan. The lender may seek to enforce that bundle of rights, promises and obligations under the security arrangements that will likely include a right to sell the secured property.

If you are considering raise funds or re-finance, for your business, please get in touch today with our experienced team at Holcroft Lawyers. 

 
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