A financing contract is more than an acknowledgement of debt; it is a bilateral agreement that can significantly influence the flexibility and future of your business. There are four important points to which you should pay particular attention.
1. Covenants: more than just figures
Covenants are the agreements and conditions set by the financier. They determine the scope of action for your company during the term of the financing. Covenants fall into two main groups: financial covenants and non-financial covenants. Financial covenants are agreements about certain financial ratios, such as the debt/EBITDA ratio or the interest coverage ratio. If these are not met, the loan can, in theory, become immediately due and payable. A tip from Xolv: ensure realistic and achievable ratios, with sufficient margin to absorb economic headwinds. Non-financial covenants include, for example, a prohibition on the sale of important assets. Or an obligation to seek the financier's approval for acquisitions, investments or new loans. These can limit your strategic agility.
2. Securities and pledging clauses: on collateral
Working capital financing often involves using current assets as collateral (pledge), such as inventories and accounts receivable. There are a number of things you need to bear in mind. A general pledge may apply to all your current and future business assets (this is a ‘pledge on all inventory and stocks’). This can make future financing from other parties more difficult or even impossible. It is also important to check whether any pledging prohibitions (assignment prohibitions) apply. Some purchase or sales contracts contain clauses that prohibit you from pledging your receivables to a third party, the financier. This can drastically reduce the value of your accounts receivable as collateral. Fortunately, this problem no longer arises in the Netherlands because the legislator has prohibited such clauses, but it is still an issue in many other European countries.
3. Cost structure and penalty-free repayment: compare fairly
The total cost of financing is more than just the nominal interest rate. There are other costs in addition to the interest. These include arrangement fees, management fees and commitment fees (these are costs to keep the credit available). If you convert the total costs to an effective annual interest rate (JRC), you can make a fair comparison. With total financing, which also includes loans, the option of penalty-free or interim repayment is important. This prevents you from incurring additional costs if your liquidity position improves faster than expected.
4. What if you fail to meet your obligations? Default and enforceability provisions
If you are unable to meet your commitments, whether temporarily or otherwise, you will want to know what will happen. Has a cure period been specified? If so, the contract will specify a reasonable period within which you can remedy any shortcomings before the lender can terminate the credit facility. A shortcoming could be, for example, a slight breach of a covenant. A cross-default clause stipulates that failure to meet an agreement with one lender (e.g. a lease agreement) can result in all other financing becoming due and payable. This significantly increases the risk of a domino effect.
Sufficient breathing space
Good guidance when assessing financing contracts is not an unnecessary luxury. A contract should not only protect the financier, but also give your company sufficient breathing space to do business and grow. Xolv Finance works with you to find the right balance!
Would you like to have your current financing structure assessed on these crucial points? Then contact the specialists at Xolv Finance for a no-obligation consultation.