Financing a business by a financial institution, such as a loan from a bank, is one of the current financing methods available to a start-up company. Before approaching a financial institution, it is essential that the entrepreneur prepare a financial plan, within its business plan, which should include the various sources of funding for the project. Financial institutions will, principally, base their analysis of the loan application on these two plans. In addition, in order to limit their risk, financial institutions will require certain commitments and guarantees from the company and the entrepreneur.
Firstly, financial institutions will request that the company be operated as a legal entity, the corporation being the most common. The offer of financing will usually provide certain financial ratios that have to be satisfied by the company throughout the term of the loan. The entrepreneur must therefore ensure that the requested ratios can be reasonably met, failing which the financial institution could claim the full reimbursement of the loan while executing is guarantees.
Various types of guarantees can be granted to guarantee the reimbursement of the loan. The financial institution will require, in almost all cases, a suretyship by the shareholders and/or the principal executives of the company. In the event of default, the financial institution will be able to request the reimbursement of the loan from any of the guarantors. Different hypothecs may also be granted in favor of the financial institution. Shares, bank accounts, receivables and/or the assets of the company may be hypothecated in favor of the financial institution. The financial institution may also request an assignment of rights in an insurance policy on the life of the principal executives of the company. In the event of the death of the executive, the indemnity payable under the policy would then be paid directly to the financial institution for reimbursement of the loan.
It is therefore in the best interest of a start-up company to properly negotiate the terms and conditions of its financing. In effect, commitments and guarantees that are too restrictive could act as a brake on the company’s growth.