arrow--ctaarrow--downarrow--leftarrow--rightarrow--upcaution--circlecheck--circlecheckclosecross--circleamerican-expressapplediscovermastercardpaypal--simplepaypalstripevisaenvelopeeye--closedeye--openheartlocation-pinfast-forwardmutepauseplayrewindstopvolumesearchfacebookglobegoogle-plusinstagramlinkedinpinteresttwitteryoutubetestimonial-icon
Open Main Menu Get in Touch

Top 10 business loan terms

Whether you are an entrepreneur surveying the financing options available to grow your business, launching into new markets or buying out a partner, this glossary is sure to provide insight into the business lending landscape.

Use this glossary as a resource, save it to your favorite links or share it with your clients and business partners whenever extra clarity on the specifics of business lending is needed.

 

Top 10 business loan terms

1. Senior debt

Lending provided by a bank or credit union, usually in the form of a loan, line of credit or mortgage. Senior debt is fully secured by accounts receivable, inventory or fixed assets.

2. Equity

Selling stocks and shares from a company for a price in return for a strategic business partnership. Equity does not carry any fixed interest, however as the company grows more of its profits are paid to the investor(s). Equity is known as one of the most expensive forms of business financing because a business owner is giving up a share of the company today and indefinitely as the company grows.

3. Working capital (WC)

Also known as net working capital, working capital is a measure of current assets minus current liabilities on a company’s balance sheet. A buyer will generally require that a minimum net working capital level is included in an acquisition.

4. Inter-creditor agreement

This is an agreement between two lenders, whereby they set the terms and conditions of their competing interests with their common borrower. It lists details of the loan priority and security.

5. Refinance

A refinance is when a business requires financing again, typically with a new loan at a lower rate of interest.

6. Conditions precedent to funding

A comprehensive listing of events that must occur before a term sheet will become binding. There are generally funding conditions included such as, investors completing due diligence and being satisfied with what they find.

7. Disbursement

Disbursement describes when a lending facility (loan, line of credit, capital debt, etc.) is released to the borrower.

8. EBITDA

Earnings before interest, taxes, depreciation and amortization (EBITDA) is an indicator of a company’s financial performance. EBITDA is used to estimate a business’ level of affordability.

9. Amortization

Amortization is the process of paying off a debt with regular payments within a certain timeframe.

10. Term

A loan term is the timeframe set by the lender before the loan can be renegotiated.

 

Additional business loan terms

Junior capital – A mix of subordinated debt, mezzanine and minority equity. It takes second position security, is more risk-tolerant, flexible and offers more innovative ways to structure business debt. No tangible assets are taken as security therefore lenders in this space rely on current and future cash flows to repay the debt. They collaborate with senior lenders and take second position security.

Subordinated debt – A middle layer of capital that falls between senior debt and equity. It ranks after senior debt if a business falls into liquidation or bankruptcy. It is more expensive than senior debt but less costly than equity and is often used as a flexible part of the financing package in an acquisition.

Mezzanine debt – Another layer of capital that falls between senior debt and equity however financing structures include an equity or quasi-equity bonus in the return requirements. Sometimes known as a patient debt because it typically has a longer period where the borrower is required to make interest-only payments; this provides great flexibility. Due to the patient nature of mezzanine debt with respect to the repayment, there is a bonus return that is tied to the performance of the business to align the interest of the mezzanine lender and the shareholder.  If the business generates more cash, the mezzanine lender will earn a higher return.

Venture debt – A modification of mezzanine finance, aimed at fast-growing technology companies with high margin, recurring revenue. Typically offered with short terms and very fast repayment options for technology companies that have a short window of growth and can repay the loan within a 1-2 year time frame.

Minority equity – Minority equity is patient, long term capital that grows alongside a company’s value. Unlike private equity, it can be bought back by the company using a redemption option.

Letter of intent (LOI) – A letter of intent is the offer that a buyer submits to a potential seller of a business and, when signed by both parties, forms the initial agreement stipulating the purchase price and key terms and conditions governing the proposed transaction.

Letter of interest – This letter is presented to the lender from a company when they are ready to pursue a business lending relationship. It dictates that they agree to the terms and conditions of a lender’s due diligence process. A letter of interest may also be called a term sheet or financing proposal.

Goodwill – Goodwill represents the value of the intangible assets acquired in a business acquisition. It arises when one company purchases another at a premium to its net book value.

Convertible debenture – Funding a loan with the option to convert some or all the outstanding balance to equity.

Royalty – A royalty is a payment to an investor based on a percentage of sales, or a fixed dollar amount per unit sold. Unlike a loan, a royalty may not have a defined end and can be expensive to the business overall. Royalties can be included as part of equity and mezzanine financing as a way for the investor to share in the success of the business as revenues increase.

Second position security – Security position relates to an institution’s level of priority with loan collateral. On a secured loan, a borrower pledges an asset (property, cash, etc.) which is used to pay out the loan in the case of default. A lender in the first position is paid before a lender with second position security.

Management buyout (MBO) – An MBO is when a management team seeks to buy the company they work for from the current owner using the security and cash flows of the company itself to obtain the capital required. Management invests their equity, akin to a down payment on a home, and borrows and/or seeks equity financing from institutional lenders for the remainder.

Management buy in (MBI) – An MBI is when a management team from outside a company raises the necessary finance, buys it and becomes the company’s new management.

Share purchase agreement – This agreement governs the purchase and sale of company shares between the vendor, management buyers and the lenders; it is sometimes referred to as a subscription agreement.

Universal shareholders agreement (USA) – This agreement is drafted by experienced legal counsel acting on behalf of the lender; it is a key security item in establishing and protecting the rights of the equity investor.

Interest-only period – A time in a loan, where the borrower makes payments only towards their interest; no principal is paid down.

High-ratio – A high ratio loan is whereby the loan value is high relative to the value of the collateral being used to secure the debt.

Debt service ratio – This ratio determines a business’ ability to afford a certain debt based on revenue minus expenses. This ratio determines if a business has generated sufficient cash/profits to repay the interest and principal on all debt taken on the business (this excludes day to day operating expenses – just loans from external parties).

Liquidity – Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market at a price reflecting its intrinsic vale. It determines a company’s ability to cover its immediate and short-term debts using its current assets.

Net worth – A calculation of a business’ overall value (positive or negative) determined by subtracting assets from liabilities. Net worth is sometimes referred to as a balance sheet or tangible net worth and it is an important indication of if a business has generated and retained profits over the course of its history.

Adjudication – This is the process where the lender gathers information about the borrower during the lending process before approving a deal.

Delinquency – When a borrower neglects making a loan payment or multiple payments are missed. Delinquencies are particularly serious when payments are later than thirty days.

Corporate credit score – A corporate credit score that rates a business on its likelihood to repay debt(s).

Personal guarantee – A personal guarantee is when an individual takes the onus of a lending facility, meaning that they are responsible for the debt any default in payment will affect their individual credit score.

Enterprise value – Enterprise value is a measure of a company’s total value and is calculated as the value of the equity, plus debt, minus marketable securities.

 

We’re here to help

At First West Capital, we are passionate about helping business owners, like you, access minimally dilutive junior capital. Connect with us today. Let’s do great things together.

Be sure to check out some of our other resources: