Lending in general
South African businesses, whether state-owned, listed or just starting up, are struggling. Retrenchments are the order of the day and a poor credit rating continues to mar funding and investor prospects. However bleak it may seem, the small and medium-sized enterprise (SME) sector in South Africa is growing by the day. Several alternative lenders have jumped at the chance to provide funding for this ever-growing sector, giving SMEs a better chance of avoiding failure.
The lending of money can be risky for both the lender (who may lose its capital in the event of payment default) and the borrower (who may become insolvent as a result of over-indebtedness), but it can also be very profitable for both parties at the end of the day.
With lending being a crucial part of any business strategy (in particular SMEs), loan documents have an important role to play. A loan agreement provides both parties with protection against the inherent risks of lending but can easily become lengthy and complex. This three-part series highlights the general informational and operational components of a loan agreement (no matter the type of funding involved) and the main reason for including such provisions.
In this Part I of the series we will take a look at the contracting parties to the loan agreement and the commercial details of the loan.
Contracting parties to the loan agreement
Some basic information would need to be included as to the identity and address of the lender and the borrower, and to the extent any security or a guarantee will be provided for the granting of the loan, the security provider/s and guarantor/s. For example, the full name, identity number and address of a natural person or the registered name, registration number and registered address of a corporate entity, should be included. Including sufficient information for the contracting parties will ensure that the parties can be easily identified and located should the loan agreement need to be enforced.
Commercial details of the loan
The essentials of any loan agreement are the specifics of the capital being made available under the loan, the interest being charged on any outstanding amount, the frequency of the payment of interest, and the repayment of the capital by the borrower. These commercial aspects of a loan are all linked to funds flowing between the lender and the borrower and as such, the loan agreement should also clearly state what form of payment (such as electronic transfer, cash or debit payments) will be accepted.
Not all loans require interest to be paid on a periodic basis during the life of the loan. Instead, interest can accrue on a monthly, quarterly, semi-annual or annual basis with payment being deferred, either for an interest holiday period or until the loan matures.
Borrowers will need to consider if the interest will be simple or compound in nature. Simple interest is simply calculated on the capital amount that has been advanced by the lender to the borrower and not yet been repaid whereas, compound interest will be capitalised on the outstanding capital amount of the loan – in which case interest will also accrue on the interest component forming part of the then current outstanding capital amount.
The lender will calculate the applicable interest rate with reference to the risk profile of the borrower (in other words, how reliable the borrower will be in paying back the loan), the duration of the loan, the type of loan, whether and what type of security has been provided, whether the interest rate will be fixed or variable and the margin it wishes to make as its reward for extending the loan to the borrower.
- Repayment of outstanding capital
Repayment of the outstanding capital and interest is of the utmost importance to the lender. Lenders will need to consider when the total outstanding amount needs to be repaid in full by the borrower. A lender may require repayment by way of instalments throughout the life of the loan or only as a bullet payment at the end. The borrower, on the other hand, needs to check whether the lender will allow voluntary prepayments of the loan prior to the maturity of the loan and if so, whether a prepayment penalty will be charged. Lenders may also wish to include certain mandatory prepayment triggers that will require the borrower to immediately prepay the loan (or a portion thereof), for example, if it becomes unlawful for the borrower to comply with any of its obligations under the loan agreement or if any security created in connection with the loan becomes unlawful or ceases to have the ranking as agreed in the loan agreement.
Lenders have the option to require security or a guarantee as collateral for extending the loan to the borrower. This would allow the lender to have recourse against the security provider or guarantor in the event of the borrower failing to make timeous payments in respect of the loan or any other default occurring.
A secured lender typically grants loans at lower interest rates than an unsecured lender due to the decreased risk of losing its capital. The type of security can range from a pledge of a share or cession of receivables (such as a debtors’ book) to registration of a mortgage bond.
It is clear that a borrower and lender have quite a few things to hammer out just to cover the basics.
In Part II of this series we will unpack the importance of representations, warranties and undertakings to cater for the nitty-gritty of a loan and how it may impact on a borrower’s business.
Nadia has a BCom and LLB and was admitted as an attorney in 2006 after having completed her articles at Jan S De Villiers Attorneys (now Werksmans). Nadia then joined Freshfields Bruckhaus Deringer LLP in Amsterdam as an associate for 4 years before returning to ENS as a senior associate in the banking and finance department. Nadia joined Caveat in 2015 and specialises in banking and finance work.