What are the features of a proposed financing arrangement that I need to understand and be comfortable with?

  • Lessee or Borrower: The entity that is requesting the funds is called the Lessee or the Borrower. This entity, by virtue of it being the borrower, is the guarantor. If the entity is a new entity or has been set up for the purpose of this specific project, then that’s fine. Some new entities (or ventures) can stand on its own, but many times, the lender will require other “support” for the transaction (in the form of personal guaranties and additional equity). Many people are fearful of personal guaranties and understandably so. However, there are ways to work with personal guaranties that can mitigate your fears and concerns.
  • Guaranties (corporate and personal): Depending upon who or what the owners are to the lessee/borrower entity, those owners, including individual investors, may be required to provide a guaranty for the transaction:
    • Corporate guaranties may be acceptable to an owner of a lessee or borrower, but some of the same principals of limitation and release, as described immediately below, will apply here as well.
    • Personal guaranties can be limited in certain ways or can be as high as 125% of the amount being financed; they can also be collateralized or not. Here are some thoughts about what to expect and what to think about:
      • Personal guaranties do not always have to be for the full amount of the transaction and they do not always have to be collateralized.
        • Depending upon how much equity the owners are putting into the project (more about that later) and how much of the financing will be of a hard asset nature (equipment), you might well be able to negotiate a limitation to, perhaps, everything but the equipment being financed. Lenders look at items being financed outside of equipment as “soft costs” and that may only be 20% to 40% of the total amount you are looking to finance (which is lot better than 100%!). They also look more favorably at higher equity investment percentages. You can also arrange for you and your partners to be responsible for only your own pro rata share portion of the ownership of the project. This means that your percentage of ownership would apply to your limitation. That is called a “several” guaranty and it is as opposed to “joint and several” guaranty. A joint and several guaranty is where if you do become obligated to repay a defaulted loan or lease and one of your partners cannot come up with his/her pro rata share of the repayment, you will be responsible for their share as well.
        • A collateralized guaranty is when you pledge some or all of your other assets that you own in support of your guaranty. The types of assets include your home, your savings and retirement accounts, stock you own in other companies, other real estate holdings, etc. I have rarely seen the need to collateralize a personal guaranty, but it is certainly a measure of one’s commitment to a project – however, there are other ways to show your commitment (see “Equity and Working Capital” section below).
        • By the way, some states have community property laws and some do not. You should know and understand the implications for you in your state. It is always in your best interest when your spouse does not have to sign a personal guaranty along with you, but you may not have a choice.
        • Further, some lenders will agree to releasing guaranties either in increments or in total over a period of time and under certain conditions. Typically, these conditions include the passage of time with a good debt repayment history and if certain financial covenants are met – an example of that could be that you demonstrate a cash collection history over a one-year period that exceeds your cash outflow needs by 125%.
  • Length of Term: The length of the term of the loan/lease can vary, but the typical term is 60 or 63 months. However, the term can range as high as 72 (or 75) months or even 84 (or 87) months. The additional 3 months noted in each example assumes that a 3 month skip payment period starts the repayment term.
  • Repayment Terms: As noted, there is often, but not always, a “skip” period of no payments at the outset of a repayment period for a project. You can negotiate a longer skip period and/or ramp-up of payments. An example would be the first 3 months at $0.00 per month, followed by 1% of the loan/lease amount per month for another 3 months, and then followed by 60 level payments. There are many permutations of this and they are generally designed to match your cash flow needs and facilitate your cash flow.
  • Interest Rates: Interest rates are charged based upon some financial index (like-term treasury rates, LIBOR, Swap Rates, etc.). Make sure you understand the index and the increment above the index the lender is charging. You will not likely be able to “lock-in” an interest rate until all the funding has been completed and the lease is about to commence. The rate should float either up or down, along with all rates, until then. This protects you if the rate goes down and the lender’s profit margin if the rate goes up – that’s fair.
  • Capital Lease (Loan) versus an Operating Lease (FMV): Although there are many more technical and financial differences, the chief difference is that at the end of a capital lease, you own the equipment and that the end of an operating lease, the lender owns the equipment. From a cash flow standpoint, you spend more on a monthly basis for a capital lease, but you own an asset (hopefully, still usable) at the end of the term. An operating lease has monthly cash flow advantages and, in effect, protects you from technical obsolescence – but like in a car lease, at the end of the term you will need to either buy (or refinance) your equipment at its then “fair market value” or acquire new equipment to replace what’s being taken back.
  • Equity and Working Capital: In many instances, a lender will require the owners of the project to provide the initial working capital as equity. If they do not believe that the amount of equity or working is sufficient, then they will work with you to accomplish increasing one or both (including finding or requiring additional equity partners for your transaction, if you do not have the resources). There are two important points to be made here: 1. The more the equity, the better – guaranties can be for a lesser amount and the interest rates charged could be less as well. 2. Working capital lines of credit can be obtained from a local or regional bank or even from the lender in the transaction already, but they will want either more personal guaranties (especially local or regional banks) or a pledge of the project’s accounts receivable.
  • Applications Fees and Other Fees: The fees generally associated with transactions of this sort include the application fee, documentation fees, legal fees and closing fees. Application fees ought to be refundable if your transaction is not approved or not approved on the terms and conditions as outlined in your original proposal, but be kept by the lender if they approve your transaction and you decline to move forward with them. Assuming there are other fees listed, they can often be negotiated and/or limited. Some lenders, depending upon your track record with them or for competitive reasons, might eliminate some of the fees.
  • Interim Funding Arrangements: This is a great feature, particularly for projects like diagnostic imaging centers, as it really helps to conserve your cash position for the start-up phase of your project. Assuming that the lender has agreed to finance the equipment and the leasehold improvements for your space, they will pay down-payments to equipment providers (they will even reimburse you if you have paid down-payments yourself) and pay progress payments to contractors. Some will even give you the money to manage the payments yourself. They usually charge interest-only on the amount you have used during the interim (“interim” being defined as “before” the full lease or loan commences).

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