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Spouse and I own a 5 y.o. business that has had steady growth/profit. We have a line of credit on our receivables and good credit/payment history with the bank. We now need financing for expansion.
Our bank is offering a 5 year term loan for this purpose. The banker noted that our receivables/ratios are better than most businesses he's looked at recently (and we are one of the few businesses that he has not re-categorized as high risk exposure). However, the bank wants us to collateralize additional personal investment property that we own.
We own properties that have provided a steady rental income for 10+ years. For obvious reasons, when the properties were recently appraised, the value had dropped substantially in the last year (though rental income has increased). Because of the drop in appraised values, they want to now secure the loan with several of our properties. The banker recognized that the property values would likely bounce back within a few years and said the terms of the loan could be renegotiated at that point.
These particular properties are currently in trust and I am the only trustee (not by my spouse). We simply divided our property trusts and business shares evenly between us. I, as trustee, must provide cross-collateralization and assignment of rents. However, only my spouse is listed as the Borrower on the promissory note (he has a slight majority share and is listed as President/Sec on the incorporation docs whereas I am VP/Treasurer).
Before we sign any personal guarantees for our business, should one of us withdraw corporate ownership in order to mitigate risk exposure/protect other personal assets? This is the only item I can find in the Promissory Note that relates to this...
"Event of Default: Any change in ownership of 25% or more of the common stock of Borrower."
We have an appt. w/our attorney to discuss all this before we make any decisions... Just curious if any of you have experience with this? Any words of wisdom?
You should double check with your lawyer, but I actually am pretty sure that, as a trustee, you cannot secure a loan with property you hold in trust. You can only secure that property if the property is held in trust for you. If it is held in trust for anyone but you, you would be violating your fiduciary duties as a trustee.
Regarding what's going on with the bank - what they want is legitimate and that's probably want most big banks will want. I would recommend that you look at other financing options because, given that you're successful, you will have other choices. Have you looked at credit unions in your area? Have you looked at smaller banks? Have you considered going to the SBA? Have you looked at any Government Business Development programs? In Michigan, for example, we have a Michigan Business Development Office that hands out loans. You probably have something similar in your state. You can also go talk to your township. Often, they have special loans too.
This is just for the state of Michigan, but it may give you ideas for other sources of funding in your state:
Have you tried to borrow money without using your properties as collateral? Please contact me at info@tsbdg.com or visit my website at Welcome. We have several loan programs that do not require collateral.
Had considered an unsecured loan but assumed the cost of money/interest rate to be extremely high as compared to the rather competitive rate our bank offers... I will look into this a bit more though...
Sounds odd to me, from what I heard from both lending side and borrowing side business associates of mine the LAST thing most banks would want would be to add exposure to real estate to their business loans. Depending on the structure of the ownership you might get yourself into a very messy tax situation too, I know several higher income folks that curse the advice to incorporate...
I suppose the kicker here is that w/o the real estate the loans are pretty much unsecured, so in that sense the bank is technically mitigating risk, but if the business you want to expand is at all cyclic in the same direction as rental properties -- POOF...
Personally if I had a non-real estate driven business and a real estate driven business I would be very hesitant to co-mingle the assets and / or spread the risk from one side to the other. If things are that complicated you really need to get some high powered advice as the legal issues and even insurability of these things is going to get messy fast.
You should double check with your lawyer, but I actually am pretty sure that, as a trustee, you cannot secure a loan with property you hold in trust. You can only secure that property if the property is held in trust for you. If it is held in trust for anyone but you, you would be violating your fiduciary duties as a trustee.
Regarding what's going on with the bank - what they want is legitimate and that's probably want most big banks will want. I would recommend that you look at other financing options because, given that you're successful, you will have other choices. Have you looked at credit unions in your area? Have you looked at smaller banks? Have you considered going to the SBA? Have you looked at any Government Business Development programs? In Michigan, for example, we have a Michigan Business Development Office that hands out loans. You probably have something similar in your state. You can also go talk to your township. Often, they have special loans too.
This is just for the state of Michigan, but it may give you ideas for other sources of funding in your state:
If you find someone else who is at least willing to talk you, you could go back to your bank and force their hand so they'll be more reasonable.
Thanks for the great advice.... I will research these alternatives (especially local govt. programs) so at least I have some negotiating leverage when I meet with the bank.... As a tax shelter, I hold my own properties in trust for myself so there shouldn't be any fiduciary violations.
Sounds odd to me, from what I heard from both lending side and borrowing side business associates of mine the LAST thing most banks would want would be to add exposure to real estate to their business loans. Depending on the structure of the ownership you might get yourself into a very messy tax situation too, I know several higher income folks that curse the advice to incorporate...
I suppose the kicker here is that w/o the real estate the loans are pretty much unsecured, so in that sense the bank is technically mitigating risk, but if the business you want to expand is at all cyclic in the same direction as rental properties -- POOF...
Personally if I had a non-real estate driven business and a real estate driven business I would be very hesitant to co-mingle the assets and / or spread the risk from one side to the other. If things are that complicated you really need to get some high powered advice as the legal issues and even insurability of these things is going to get messy fast.
Maybe the bank wants to secure the loan on the history of positive rental income/Assignment of Rents similar to a line of credit on Accounts Receivable? Our rental business and corporation have nothing to do with each other and are not dependent on the same real estate cycles.... I also hesitate to co-mingle them on the principle that this diversification has been what has gotten us through many tough times (e.g. when business was down, rental stream was up and vice versa)...
Chet, I know you're from Chicagoland and tend to give good advice... Do you have any recommendations in Chicagoland/NW burbs on law firms specializing in this? I haven't been that impressed with our corporate attorney as I've actually found several mistakes in his documents which he had to correct (and I have absolutely no legal background!).
I have to tell you that I too have not impressed with the kind of lawyers I can afford, and the kind of lawyers that I have met that impress me are not the kind I can afford...
The really highly specialized people in large firms or small "boutique" firms tend to bill like rock stars and I never had anything that was that valuable enough to afford 'em. The little guys that I have used know the technical details that I do not, and of course have the ability to sign off on the stuff that would result in an obvious problem, but the money I spent with 'em often meant I would have to call them (or their secretary / paralegal) back many times to fix everything from spelling errors to improper dates (seems lots of folks use MSFT Word and just 'auto insert' what ever date the silly thing suggests whenever they start spelling our a month/day combo instead of double checking that sort of stuff -- hugely annoying that I was always the "proof reader"...)
The best "small firm" type lawyers that I ran into tend to be the guys that have their own little side investments in real estate as they understand the kinds of issues that come up for a landlord, but these are also the kinds of people that often do not spend enough time in the office to answer your questions and such. Catch 22...
Big firms like to throw younger people at small fish and then you get billed for the youngsters hours AND that of their mentor. Adds up real fast.
My gut (and some first hand experience)tells me that smaller towns that have the County Seat in 'em can have some pretty good "generalists" in places like Wheaton or DeKalb or Geneva, but these guys don't even know the address of all the field courts in C(r)ook Co... Sorta of "big firm" dominated county for a reason I guess...
Our rental business and corporation have nothing to do with each other and are not dependent on the same real estate cycles.... I also hesitate to co-mingle them on the principle that this diversification has been what has gotten us through many tough times (e.g. when business was down, rental stream was up and vice versa)...
My initial reaction was exactly the same as what you've said above. You have two independent businesses that balance out variations in your income stream. I would be very leery of doing anything that would tie both of them together in the event that hard times fell on one of your businesses and limited your ability to rely upon the other one to carry you through.
I'd also be very cautious of a banker who says that you can renegotiate the terms in the future when real estate values go up. We don't know what the next five years hold and you could get really jammed up if market values fall over that time frame. Your rental business is not impacted by market value right now, but it certainly could be if you have those properties tied in to your other business loan. I'd hate to see you forced to sell cash-flowing real estate in order to refinance your business loan in five years.
I'd also do everything in my power to avoid a personal guarantee. I've seen those guarantees come back and bite people. Hard. Since you have an established business that is growing, that should give you quite a bit of leverage. Of course, a lot depends on the type of business you have and what the loan will be used for. Just the same, I'd keep business and personal as far apart as possible.
I have to tell you that I too have not impressed with the kind of lawyers I can afford, and the kind of lawyers that I have met that impress me are not the kind I can afford...
Unfortunately, I'm in the exact same boat.... And I'm also constantly proofreading legal docs to find obvious errors due to Word search/replace mistakes... I think there is some free legal service offered at the SBA office in our area. They also pair up newer business owners with retired owners who act as mentors. I may look into this...
I'd also do everything in my power to avoid a personal guarantee. I've seen those guarantees come back and bite people. Hard. Since you have an established business that is growing, that should give you quite a bit of leverage. Of course, a lot depends on the type of business you have and what the loan will be used for. Just the same, I'd keep business and personal as far apart as possible.
Thanks for the advice... I have triple checked the paperwork and spoke to my attorney and there is not a personal guarantee on the Note. So that's good. The bank (a major U.S. bank BTW) just wants the loan secured with properties which is legitimate. But I'd like the money unsecured. I am meeting with the banker to see what leverage we may have.
I fully believe in our business model and our direction and am comfortable taking risk. Product sales have picked up substantially since April and we are also expanding our service business (one of the reasons we need the money).... It's just the risk of putting up this property...
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I am meeting with the banker to see what leverage we may have. 
