The owner of a rapidly growing company recently ran into unexpected road blocks when he tried to borrow money to finance his business’s expansion, not because the lender doubted his ability to pay, but because the previous loans the owner had taken meant that the new lender would not be first in line to get paid in case he defaulted.
As explained by Ami Kassar in his recent New York Times blog post, In Small-Business Lending, the Devil Is Often in the Lien, even a company with strong revenue and credit history can face difficulty getting new funding if previous lenders have placed holds on the business’s assets.
This happened to one of Ami’s Multifunding clients, a firm that helps identify the right forms of funding for businesses. Fortunately, Multifunding helped their client out of the situation, but it was costly. The borrower had to use its second loan to pay off its bank loan and an equipment loan at high cost.
These restrictive holds are called liens and are often overlooked by small business owners who are caught up with other terms of their lending agreements like interest rates and monthly payments, according to Ami.
In order for you and your business to avoid a similar situation, it is important to first understand what a lien is. A lien is a lender’s right to take a hold of the property belonging to a borrower until their debt is paid off. As Ami explains in his post, borrowers often overlook this important risk while they’re caught up with other loan terms.
When a borrower takes out multiple loans, liens get tricky. Lenders prefer to be in first lien position, meaning they have priority to take a company’s assets until the debt is repaid—first position is awarded to the first lender you borrow from. If a lender is in second, third or an even lower priority lien position, they must wait until the first priority lender collects its money to receive their cut. This is obviously a much riskier position, and the secondary lenders will most likely require higher interest rates.
As the layers of liens build up, the company will be borrowing at high cost so it is important to manage these carefully to avoid issues like those Ami’s client faced.
Ami Kassar was a speaker at Access to Capital in Chicago. His firm is a great resource for business owners to educate themselves on all of their loan options. He is also a regular contributor on the New York Times’ Small Business blog, which is another great resource for small business owners.
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