Loan agreements: What businesses need to know

Loan agreements: What businesses need to know

Introduction

Access to finance is a critical component for business growth, whether for expansion, business purchases, operational stability, or investment in new ventures. Loan agreements can provide businesses with structured financial support but come with legal and financial obligations. Understanding the key terms, clauses, and risks associated with loan agreements is essential for businesses to make informed borrowing decisions.

A well-structured loan agreement can help to protect both lenders and borrowers by defining repayment terms, interest rates, preconditions to lending, ongoing obligations that apply during the loan, and consequences of default. This article explores the essential components of business loan agreements, different types of loans, and legal considerations businesses might want to keep in mind before signing a loan contract.

What is a loan agreement?

Put simply, a loan agreement is a legally binding contract between a lender and a borrower that outlines the terms under which a business borrows money.

Types of business loans

1. Secured loans

A secured loan requires the borrower or a related party, such as a director or a parent company, to provide assets (such as property, shares or plant) as collateral. If the business defaults, the lender can take possession of the assets with a view to realising those assets to recover amounts owed to them by the borrower.

• Pros: Typically, interest rates are lower and borrowing limits are higher, on the basis that there is security for the loan which, put broadly, would make the loan less risky from the lender’s perspective.
• Cons: Risk of losing assets if repayments are not met or other obligations of the borrower and/or security provider are breached.

2. Unsecured loans

Unsecured loans do not require collateral, making them riskier for lenders. As a result, they often come with higher interest rates and stricter qualification criteria.

• Pros: No asset risk for the borrower.
• Cons: Higher interest rates, lower borrowing limits.

3. Term loans

A term loan provides a lump sum amount that is repaid over a fixed period, typically with a set interest rate. These could be ideal for long-term investments like purchasing another business or equipment or expanding business operations.

4. Revolving credit facilities

Similar to an overdraft, a revolving credit facility allows businesses to withdraw funds up to a pre-approved limit and repay them flexibly. These can be useful for managing cash flow fluctuations.

5. Bridging loans

Short-term loans designed to cover immediate funding needs until long-term financing is secured. These are common in property and some corporate transactions.

Key components of a business loan agreement

1. Loan amount and repayment terms

• Defines the principal amount borrowed.
• Outlines the repayment schedule (e.g., monthly, quarterly, or annually).
• Specifies early repayment options and any associated fees.

2. Interest rate and fees

• The interest rate can be fixed (stays the same) or variable (fluctuates with market conditions), or the loan may not have any interest payable at all.
• Additional fees may include arrangement fees, prepayment penalties, or late payment charges.

3. Security and collateral

• Secured loans will detail the security required by the lender, with the security itself being documented in a separate and different type of legal agreement.
• Businesses should assess the risk of being able to comply with the loan agreement and security throughout the term of the loan, bearing in mind the consequence of breaching these obligations which could lead to the loss of key assets.

4. Default and remedies

• Specifies what constitutes a default (e.g. the offence that would constitute a breach of the obligations under the agreement, such as missed payments or insolvency).
• Outlines lender’s rights, following a default including legal action or asset repossession.

5. Covenants and obligations

Loan covenants are contractual promises the borrower must meet for the entirety of the term of the loan to avoid being in default of the agreement. These can include:

• Financial covenants: Maintaining a minimum revenue level or debt-to-equity ratio.
• Operational covenants: Restrictions on selling assets or taking on additional debt.
• Reporting covenants: Requirements to provide regular financial statements to the lender.

6. Guarantees and personal liability

Some lenders require directors or business owners to personally guarantee the loan. This means personal assets could be at risk if the business fails to repay the loan.

Further Resources

Financial Conduct Authority (FCA)

Expert legal support

Our specialist Business Solicitors provide expert advice across a full range of commercial services.

If you are considering taking out a loan or providing a loan, our Corporate Team can discuss with you how putting in place a simple loan agreement can give everybody peace of mind that everything has been properly agreed. Our experienced team regularly helps our clients negotiate and draft such agreements and would be happy to discuss with you your particular set of circumstances and how we can help.

Contact us for more information.

This article was produced on the 19th May 2025 for information purposes only and should not be construed or relied upon as specific legal advice.