We have seen a rise in businesses obtaining loan finance from friends, family or business associates across a range of sectors, including marine and real estate development. This may be as a result of perceptions concerning the pressures that economic uncertainty poses to commercial lending institutions, such as regulatory change and potential loss of passporting rights, or simply that a loan to a trusted family member or friend can seem more attractive than current commercial interest rates.
Before entering into loan arrangements, there are some key matters that lenders should bear in mind – particularly in light of the current economic uncertainty.
Have you done your due diligence?
Are you comfortable that the intended recipient will be able to meet the repayments? You may wish to see business plans, projected cashflows, or other evidence.
Do you need any security?
If you do not have security such as a legal charge over property, you will be an unsecured creditor and in the event of the borrower’s insolvency, you will have no greater right to be repaid than any of the borrower’s other unsecured creditors. In fact, if other lenders do have security, they will have a greater priority to the borrower’s assets than you do. You may also consider whether a guarantor is required in order to provide additional security.
Are the terms sufficiently clear?
A simple IOU may sound tempting in respect of a borrower that you respect and trust. However, it is worth bearing in mind that the borrower’s circumstances may change and you may ultimately end up seeking to enforce against an insolvency practitioner or even the estate of the borrower. The agreement should clearly articulate the amount of the borrowing, any interest or other costs that are payable, and when it is to be repaid. Additionally, it may be useful to include other provisions giving comfort that the borrower will be able to repay. For example, provisions enabling you to access financial records or controlling the borrower’s conduct.
Are there any regulatory issues to be aware of?
Lending to an individual or to certain partnerships in the course of business is a regulated activity which is prohibited by consumer credit legislation unless it fits within one of a number of exemptions. The legislation is complex, and even the meaning of the phrase “in the course of business” is not as clear as might be envisaged. A failure to comply can result in the loan being unenforceable and the lender potentially incurring criminal liability. Secured borrowing can also bring with it regulatory issues which need care to address.
Are there any alternatives?
It is no secret that money can be a source of contention between family members or friends and taking enforcement action in respect of unpaid debt can have significant impacts on relationships. It is worth considering at the outset whether, in the light of all of the circumstances, it is necessary or appropriate to do so. Commercial lenders continue to offer some excellent investment and business finance products which may represent a better overall option. However, if you do intend to finance a business, it is worth ensuring you have sought legal advice at the outset.