Financing Commercial Transactions – Part 2
By Keith Dunnagan, Senior Transaction Attorney
In the previous post we addressed various avenues to obtaining funds for project, whether those funds come from institutional sources or non-traditional sources. Once you have narrowed the field of where you will seek financing, the borrower will be looking for a letter of commitment from the financier which will put forth the general terms of the agreement.
It is important to spend some time on this document as these general terms will follow you all the way through the actual contractual phase of the financing and the execution of the loan documents. Aside from the plethora of bad things that can happen if payments are not made, the first issue is to be addressed by any would be the borrower’ equity injection. In every commercial loan, the financier will require the borrower to have a certain amount of cash infusion into the project. While equity infusion can vary widely (SBA in some situations only requires a 10% equity infusion into a project) the general standard for equity in a commercial project will be somewhere between 25% and 35% of the total project costs. When discussing a $10M project, that can be significant amount of money that a borrower is required to put into the project.
Once a borrower understands their equity requirements, they can then focus on how to fund that capital infusion. For some borrowers, the obvious answer is to self fund the equity requirement. This has significant benefits and drawback, on the plus side, there is no profit share or management share with outside individuals. Which means all the gains and control of the business remain with the borrower. However, it also means that the entire risk of loss falls on the shoulders of the borrower. Others, especially in the development arena look to investor capital through joint ventures, which generally comes from established and well funded capital groups, wealthy individual investors, Wall Street investment firms or venture capitalists. This brings investors in to the picture that are typically looking for generous returns in exchange for risking their capital. This necessarily requires some diluting of the profit returns and giving up control of at least some portion of the business. The goal is always to retain majority control of the project, but depending on the amount of equity required, that sometimes becomes unrealistic. A new medium for equity raises is the rise of crowd funding. Crowd funding is more or less a method of raising funds, generally through the internet from a bunch of smaller investors. The JOBS Act of 2012 and Reg D have created a path to using the crowd funding method, while the borrower is benefited in that crowd funding provides the borrower a larger and more accessible pool of investors to raise the required capital, the borrower also must be aware of the source of the crowd funding dollars because the SEC does regulate and limit those who can invest. Namely, an individual generally must be an accredited investor under the SEC guidelines.
Once the borrower understands its equity requirements and has narrowed the field of potential sources of borrowed capital, the process now becomes one of understanding what type of security and guarantees will be required and what actions will be necessary of the attorney involved in documenting the loan. Remember, your lender has multiple attorneys looking at your commercial finance documents prior to execution, you should have at least one competent attorney looking at the documents as well. These requirements will almost always require a deed of trust against the real property which is the subject of the financing (I say almost because I know of a transaction where no Deed of Trust was provided as security). Other forms of security, include assignments of rents, UCC-1 Financing statements against personal property (notably inventory and equipment), and hypothecation (a fancy legal word for “pledge of an interest in some property as collateral for a debt”) of interests in business entities (that can take the shape of a pledge of shares of a corporation or a pledge of membership interests in an LLC). Additional forms of security for a lender include corporate, trust and personal guaranties of debt that require the signor to also covenant to pay a debt in the event the borrower fails to pay.
As a final piece to the lending puzzle, is whether the lender will require the Borrower’s attorney to provide an Attorney Opinion Letter. These are terribly expensive exercises for the Borrower as such a letter essentially require the Borrower’s attorney to provide an opinion that can be relied upon by the lender that the loan documents are valid and enforceable instruments under state and sometimes federal laws. A borrower to the extent possible should be looking to avoid such a requirement.
In the next article we will take a glance at promissory notes, what common issues are presented in with the promissory note, including actions a borrower generally must take and actions a borrower is generally prevented from taking. Stay tuned.
If you want to know more or need assistance with your project, contact me, Keith Dunnagan, at email@example.com or by phone to our office at 916-966-2260.
BPE Law has been assisting our clients with their real estate, business, and estate planning needs ever since we started doing business. We’re active in the communities in which we live and in protecting and assisting our clients legal interests. If you have legal questions, give us a call at 916-966-2260 or e-mail me at firstname.lastname@example.org. Our flat fee consult for new clients may get you the answers you need for the questions you have.
The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are facing a legal issue of any kind, get competent legal advice in your State immediately so that you can determine your best options.