A business loan agreement is a legal contract between a lender and a business borrower that outlines the terms of a loan. It sets out a plan for repayment, with interest, and any other guidelines that are important to the financial arrangement.
Businesses often need loans to fund their endeavors and build their company. Lenders need to make sure they secure their interests in money they lend to businesses. In either case, a business loan agreement template can help you build your own.
What is a Business Loan Agreement?
A business loan agreement is a document that details the logistical, financial, and legal obligations of the parties to a loan agreement. The business borrower requests money and takes on a debt to secure funds. It details a loan repayment schedule by which the borrower must repay the borrowed funds, including conditions for early payment or default in payment.
Every business loan is different, but using a template helps you get started on the substance of the document while allowing you to modify it to fit your needs.
When to Use a Business Loan Agreement?
Whenever you lend money to a business, you should use a business loan agreement. Even “small” loans to a friend’s business should be put down in writing. Without this writing, significant disputes may arise over repayment. These disputes could end up in court and you may not be able to enforce your agreement if you do not have a written business loan.
A business loan contract form should also be used if you are a borrower, and you are not offered a business loan contract. This form details protections for the borrower as well as the lender. Both parties should want a written agreement to ensure they understand important details like when the loan should be repaid, in what amounts, and what the applicable interest is for the loan.
You may want to use a business loan agreement for:
- Major asset purchases
- Business purchase agreements
- Borrowing from a bank
- Lending to a startup business
- Purchasing parts or products to build up an inventory
- Purchasing land or a building
How to Write a Business Loan Agreement
When you need a business loan agreement, you may feel nervous about starting one from scratch. With a simple business loan agreement, you can make one yourself and modify it to make any changes you need. Here’s some of the key information you should ensure is included in every business loan agreement:
Step 1 – Set an Effective Date
This is the date that money is provided to the borrower. This date is crucial, as it sets the repayment schedule which will follow. Typically, the effective date is the same date the document is signed. However, the contract loan agreement can choose a different effective date.
Step 2 – Identify the Parties
The two (or more) parties to the loan agreement should be identified in the agreement near the beginning. This should be information about both the lender and the borrower. Information should at a minimum include:
- The names of the parties, including business names
- Names of officers and signatories to the agreement
- Business and personal addresses as applicable
- Contact information, including a phone number and email
- Service of process information for business entities
- Any co-signer and their information
Step 3 – Include the Loan Amount
When you make or receive a loan, you should clearly identify the amount early in the document. The total amount will help determine how the payments are made in the future and how interest may affect the total loan. At the beginning, this is the principal amount of the loan, prior to the imposition of any interest.
Step 4 – Create a Repayment Schedule
The loan should include when repayment starts and the periods at which each payment must be made. This could be monthly, quarterly, yearly, or any other time period. Repayment may start right away on the loan, or at a later date.
A schedule, often an amortization schedule, is included or attached to the business loan contract to clearly identify the repayment timeline.
Step 5 – Define Security Interests or Collateral
Many loans will help secure repayment by using collateral. This is some type of personal property or secured interest in real property that may be collected upon in the case of a default. This is especially common in mortgage agreements but is common in many other kinds of agreements as well.
Step 6 – Set an Interest Rate
The interest rate is the amount the lender charges, in a percentage, of the principal for the loan amount. This amount is important and is often subject to significant dispute when it is not set down in writing.
Most types of loans require interest for repayment. It is how the lender makes money on the loan. Interest rates are often determined by the current market, the risk of giving the loan to this particular borrower, and many other factors. This section should also identify the type of interest rate, such as a fixed or variable interest rate.
Step 7 – Late Payment Fees
Nearly every loan agreement, especially for business entities, comes with penalties for late payment. This can cause late fees or charges, increases in interest rates, or other methods to deter late payments by the borrower.
Late payment, or continued nonpayment, may result in a default on the loan. A default should be fully considered in its own section of the loan agreement.
Step 8 – Determine Prepayment Options
The loan may or may not include a prepayment penalty. This creates a fee if the borrower pays off the loan ahead of schedule. Not every loan comes with prepayment penalties. It is up to the lender whether to include this provision or not. On the other hand, if the borrower pays all of the loan before a certain date, they could receive a discount.
Step 9 – Define Conditions of a Default
A borrower defaults on a loan when they fail to pay it back as required by the business loan agreement. It is crucial to define how a default will be determined. Some loan agreements state that one missed payment may result in a default. Others are much more forgiving.
A default can result in the acceleration of the loan if that provision is included. This means that default makes the entire amount due and owing right away. It also gives the lender a legal right of action against the borrower in most cases.
Step 10 – Have a Well-Defined Signature Section
The parties to the loan need to sign the agreement to be bound to it. Not only should the business officer sign on behalf of the business, but any personal guarantors or co-signers must also sign at this time. The signature lines should make clear whether the signatory is signing in their individual capacity or on behalf of the business.
Business Loan Agreement Sample
This sample of a business loan agreement can help you get started in drafting your own loan.
Business Loan Agreement
Tips to Consider When Writing a Business Loan Agreement
When writing a loan agreement, you should follow a few best practices that can help you create an easy-to-use and enforceable contract:
- Understand key terms: There are many terms in a business loan agreement you need to know. These may include “balloon payment,” “amortization,” “factor rate,” and much more. Know every term used in your contract to know what it means.
- Consider co-signers or guarantors: Many businesses, especially startups, are risky investments. A co-signer or guarantor agrees to pay the loan if the business itself is unable to do so. Personal guaranties can help ensure you get paid for the loan you provided.
- Use appropriate attachments: Many business loans are complex documents. If you want to include additional documents to support the loan agreement, add them to the loan agreement and incorporate them by reference. This might include a purchase agreement or other business documents related to the transaction.
Disadvantages of Not Using a Business Loan Agreement
There are many disadvantages when you fail to use a business loan agreement. For lenders, these disadvantages include:
- Lack of enforceability for the loan
- Unclear repayment terms on which you can rely
- Decreased likelihood of timely repayment
- Inconsistent lending standards for customers
There are disadvantages for borrowers as well, including:
- Unclear expectations about what you owe and when
- Potential for high-cost litigation over the terms of the loan contract
- Possible abuse by a lender in forcing early repayment
- Possibility for higher interest rates or fees than originally agreed
Business Loan Agreement FAQs
Yes, a business loan agreement is a legally binding contract. When all of the appropriate information and signatures are included as part of the contract, the court will very likely enforce the agreement. A well-drafted agreement can help you ensure that the agreement will be enforced.
While they are similar, business loan agreements are usually more detailed and need the signature of both the borrower and the lender. Promissory notes spell out a promise to repay a loan but offer little other information relevant to the transaction.