Keeping track of your business loans

Sue Gull, Corporate Services Partner at Scrutton Bland, reminds businesses to review their business loans to keep on the front foot during COVID-19.
 
Loan covenants are a standard part of a commercial loan agreement, but the impact COVID-19 has had on many businesses over the past few months has meant the conditions imposed may not always be appropriate for a firm’s current situation. Corporate services partner Sue Gull looks at whether existing loan covenants may need to be redrawn to avoid difficult consequences further down the line.
 
A loan covenant is a condition attached to a loan agreement between a business and a lender, such as a bank. The covenant is part of the legal agreement drawn up to protect both parties: the lender needs to know that the borrower’s ability to pay back the loan has not been jeopardised either by actions that the borrower has taken or events that have had an impact on the performance of the business. The borrower needs to have the agreement in place to protect the terms of the loan, in respect of both repayment terms and interest rates.
 
The conditions set out in the loan covenant are part of the formal business loan agreement and in many cases will be tailored to the business risk.  For example, the lender may state that the annual  profits before tax and interest must amount to at least three times the annual interest charge on the loan. For a business investing heavily in assets, a cash flow covenant may impose limits on capital expenditure. Whatever the criteria, the business owner must agree in writing that these terms are acceptable for the duration of the loan and in the event of a breach of covenant, the lender will frequently have the right to demand immediate repayment.
 
With all the unexpected consequences of COVID-19 and with Brexit on the horizon as well, many businesses may well have signed up to covenants which simply cannot be met in this rapidly changing environment.
 
Whilst many lenders will take a pragmatic approach to the situation and can agree to waive the strict application of the agreement terms, a breach of a loan covenant can have far reaching consequences for the business. This is especially true where the lender has not been forewarned of a potential breach.  As well as being on the back foot for negotiations on future facilities, a breach can result in a detrimental impact on published accounts and credit ratings.  For example, if the loan has to be shown as falling due within one year, important liquidity ratios used in establishing credit ratings can be adversely affected.
 
Checking that the business has met its covenants and will continue to do so is an important aspect of your financial control process and should be an accepted part of the monthly or quarterly financial reporting regime.  Highlighting potential breaches and taking action with the lender at an early stage will give the business a chance to negotiate appropriate covenants which reflect the current situation or, in the worst case scenario, can give the business time to seek alternative sources of finance.
 
Sound financial information is the first step to identifying issues and taking early action, before you find yourself on the back foot. Our team at Scrutton Bland have extensive experience of the issues arising around financing and the options available. We frequently work with clients to advise and support them through the process of securing appropriate finance. Our knowledge of alternative options can help you in negotiations especially if you find yourself in a stressful situation and need an objective and trusted adviser to bounce ideas off.
 
Finally, if you do need to talk to a financial adviser, do ensure that they are independent. At Scrutton Bland we deal with all banks and lenders without incentive or commission. We have been providing accountancy services for over one hundred years and have a strong track record in audit and accountancy for businesses at every level across our region and beyond. Having an experienced financial adviser on your side will help you deal with your present circumstances, as well as plan for the future – and to always be on the front foot when it comes to regulation and compliance.