Understanding Bank Loan Covenants

There's more to a bank loan than the interest rate. If you're securing a loan for your business from a bank, be sure to consider carefully the covenants in the loan agreement. Put in place to safeguard the bank, loan covenants can stipulate everything from financial ratios that the borrowing company must maintain to salary caps for its executives. What's more, any violation of an agreed-upon covenant can signal to your banker that something might be awry at your company, and you run the risk of having the loan called in.

Understanding loan covenants before you sign on the dotted line can help you better comply or, perhaps, prepare to negotiate more realistic covenants.

The following five steps should help you navigate the loan-covenant jungle and put you in a better borrowing position:

1.  Find out whether your prospective bank plans to retain your loan or sell it.

     In the latter case, there's probably less room for maneuvering over covenant issues.

2.  Inquire about the bank's expertise in – and funding experience with -- your industry.

     covenants from industry specialists are often more realistic.

3.  Ask to see a sample list of covenants before the date of the closing, so you can avoid a

     situation in which desperation for funds -- or a lack of careful analysis – persuades

     you to simply sign anything. Make certain that you can live with the bank's terms

     about the consequences of going out of compliance.

4.  Do a computer run of your company's past performance during the most recent one

    -two-, and three-year periods to see if you could have complied with all loan

    covenants, especially key ratios, if you loan had been in place before now.

5.  If those results indicate future problems, schedule a visit with your banker and suggest

     more realistic covenants.

Or……. Give One-For-The-Money a shot at handling your financing.  There are no covenants to worry about.  Your loan will be based on the appraised value of the real property and on “common sense” underwriting by using either the DTI (Debt to Income)

approach or the DSCR (Debt Service Coverage Ratio)