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Business Loan Covenants

Sick of doing that pesky covenant reporting imposed by your bank? You can avoid it with these simple tricks

Business loan covenants or undertakings are terms set out by the lender when they approve a business loan.

Essentially, the borrower must meet certain benchmarks or take certain actions on a regular basis so the bank can be confident that the business is profitable and that you can continue making your repayments.

Meeting the reporting requirements can be difficult and time-consuming but there are ways to negotiate business loan covenants.

How do business loan covenants work?

As part of the terms of the business loan, the bank will provide you with an undertaking reporting schedule that sets out certain requirements and rules that must be adhered to, typically on a quarterly basis.

This includes providing up-to-date financials, meeting your tax obligations and hitting certain revenue benchmarks. Negotiating these covenants comes down to the strength of your business and the amount you’re borrowing.

Can I avoid undertakings?

Yes! There are a few ways that you can avoid business loan covenants, although it largely depends on your application and the lender you choose.

Keep your loan under $1 million

As a general rule, business loans for under $1 million fall within some lender’s small and medium-sized enterprise (SME) department.

Because of this, there are some lenders that are willing to “wear the risk” of the business loan without requiring the borrower to meet undertakings.

Maintain a low Loan to Value Ratio (LVR)

Business loans that are for less than 50% of the value of the property that you’re using as security (Loan to Value Ratio) may also help you to avoid covenant reporting.

Run a strong business

If you can provide an accountant-certified business plan showing cash flow projections as well as evidence of successfully running a similar-sized venture in the past, you may be in a position to negotiate on the need for a business loan covenants.

Sometimes it may just be a case of successfully running your business, meeting your financial commitments and making your business loan repayments for 2-3 years, after which, you can request to remove the need for covenants.

Good clients have the power to tell the banks that they will take their business elsewhere if covenants aren’t removed.

With the help of a mortgage broker, they’ll usually listen to you!

Banks would rather keep a strong business client then lose them to another bank and the mortgage broker will even help you negotiate a better interest rate on a regular basis.

Are you in a position to negotiate on business loan covenants?

Call us on 1300 889 743 or complete our free assessment form so we can assess your situation and tell you how we can help.

Common business loan covenants

The number and kinds of covenants that a business must meet as per the terms of the loan vary depending on the strength of the borrower and how much the bank is lending to you.

To give you some idea, the following is a set of business loan undertakings from a major Australian lender:

  • Notify the bank of any formal agreement entered into by the customer and/or guarantor with the Australian Taxation Office (ATO) or the State Revenue Office for the repayment of tax obligations.
  • For companies and partnerships, to provide within 270 days after the end of the financial year, copies of all financial statements for that financial year. This includes balance sheets and profit and loss statements (P&Ls) prepared by an accountant.
  • For individuals, a statement of assets and liabilities and income and expenses.
  • Evidence of satisfactory tax position: This typically means that the company director has to sign a declaration that all of tax, business activity statement (BAS), payroll, goods and services tax (GST) and superannuation contribution obligations have been met on time.
  • You cannot borrow or ask a guarantor to secure a loan for more than $100,000 without the bank’s written approval: As long as you get bank permission, you can still get a loan for your business if you have sufficient equity in a existing residential property to use as security.
  • Must notify the bank of any trust arrangements in place in relation to legal ownership of the business and any associated assets: This is basically referring to whether a director has created a new trust which affects the ownership of the business.
  • Must not change control over the company without written consent to the bank.
  • Ensure all of your transaction banking arrangements and deposit facilities are transferred within 90 days.
  • Must provide the bank with management accounts when requested.
  • Insurance requirements: This can vary from having adequate property insurance in place (if you own the freehold as well) to the director/s having Total Permanent Disability (TPD) and key man risk insurance. The bank will just want to see that you’re maintaining these insurance repayments.

Businesses are also expected to maintain certain gearing ratios such as:

  • Drawings (the personal income that the owner draws from the business) must not exceed 100% of net profit.
  • Earnings before interest, tax, depreciation and amortisation (EBITDA) to be a minimum of $420,000 per annum.

Does this all sound too confusing?

Remember that a financial professional like an accountant can help you to stay on top of your covenant reporting.

Better yet, a specialist mortgage broker may be able to negotiate to reduce the number of undertakings that you’re required to meet or even remove the requirement altogether.

Why do banks have covenants on business loans?

Generally speaking, business loans are considered riskier than not only residential home loans but loans to buy freehold commercial property.

The bank is putting a lot of faith in your ability to stay profitable and continue to make your repayments.

If the business goes bad, the bank can burn a lot of money very quickly should you default on the loan.

Even though you’ll be securing your business loan (typically) with a residential property that you own, the business is your sole source of income.

Let’s say the bank is forced to sell your pub because you default on the business loan and the pub can’t be sold simply because of the state of the market.

The bank could easily lose around $10 million and that would be written off as a loss. It’s something the bank wants to avoid at all costs!

It’s for this reason that covenants can often be quite comprehensive, particularly when it comes to having good liquidity to deal with changes within the business or the wider industry.

Business loan covenants FAQs

One of the most common mistakes with business loan covenants is that new borrowers simply don’t read their reporting schedule properly before signing the loan agreement.

Very quickly, borrowers can find themselves in default because they failed to comply with one of the undertakings.

What happens if I meet covenants?

If you meet the reporting schedule requirements, the bank will sign off and you can continue running your business.

Occasionally, they might also provide some commentary around the financial position of the business.

For instance, they may make a note that the profit on your P&L was lower than the last review or that you were late in making your GST payments to the Australian Taxation Office (ATO).

What happens if I don't meet those benchmarks?

If you “fail” covenants, so-to-speak, it’s not necessarily the end of the world.

The bank may ask whether you’re taking too much money out of the business and whether it’s for personal reasons such as being unable to work due to sickness.

Most lenders want to work with its business clients so they don’t lose them to another bank.

Generally speaking, a bank will give you around 3-6 months to get your financials prepared and/or to meet the financial undertakings set out in the reporting schedule.

Of course, not all banks are the same, particularly if you haven’t met some of the covenants in the past.

In the best case scenario, they will move to “re-price” your business loan, reducing the Loan to Value Ratio (LVR) and requiring you to come up with more funds or to put up more equity as security.

If they see enough of deterioration in the financials, they can set a higher interest rate if you haven’t fixed your business loan!

In the worst case scenario, they can move to sell the business and your assets to pay off the loan.

If you’re in this situation, please fill in our free assessment form and we may be able to refinance you to a lender that will offer more favourable business loan terms and at a better price.

Will the bank look at the current lease agreement?

Although it doesn’t fall within the reporting schedule, your bank will definitely want to know what the lease arrangement is before they approve your business loan.

The business loan term is typically the same as the lease term so at the end of the term, they would want to see that you have a new lease in place or at least somewhere else where you can run your business from.

Covenants vs annual reviews

Covenants are different to annual reviews in that it happens more frequently, typically on a quarterly basis.

Both a covenant reporting schedule and business loan annual review require you to provide the same documents but the big difference with an annual review is that the reporting requirements are yearly and the bank will provide commentary of the wider industry in which you’re operating.

For example, if you’re running a retail shop that relies heavily on fly-in fly-out (FIFO) clientele in a mining town, the bank would be keeping an eye on if and when the mine closes.

The bank can request financials at any time!

Whether it’s for covenant reporting or a business loan annual review, the bank is within its right to request that you provide your financials and other business documents for the last 28 days at any time they see fit.

It’s crucial to be on top of your bookkeeping so you may want to consider hiring an accountant who can help do all of this for you.

Do you need some extra finance to kick-start your business?

Often business owners who have fallen on hard times just need a small business loan to cover their suppliers or unpaid client invoices.

Once they get that little finance kick, they can get back on track with the business.

After seeing your financials, your current bank may not be willing to offer any more business finance but we take a more common sense view when it comes to business owners.

We know lenders that may be able to help!

If you have enough equity in an existing property, you may be able to borrow up to 85% of the property value with a business equity loan.

Call us today on 1300 889 743 or complete our free assessment form if you recently didn’t meet covenants and you’re worried about defaulting on your business loan.

Speak to a business loan specialist

As a mortgage broker, we can give your business loan a health check.

Send us your position and we can let you know if we can you better terms and at a much better interest rate.

Business loan covenants are all negotiable if you can build a strong case with the right lender so call us on 1300 889 743 or complete our free assessment form today.

We’re business loan experts!